Sure. You can structure the compensation however you like as long as it is fully disclosed in your NFA-approved ddoc. The most common methods of compensation are a percentage of assets, a percentage of profits, perhaps with a highwater mark and/or hurdle rate, and a portion of commissions. If you wanted you could have a flat fee, a sales load, a redemption fee, whatever. Your "100% of everything over 50% profit" is a 100% incentive fee with a 50% hurdle rate. I would be wary of this fee structure as an investor. You have a call option on all profits above the 50% hurdle rate. This is a deep out of the money call. The value of deep out of the money options is highly dependent on the underlying volatility. You, as the manager, have a big incentive to take on a lot of risk/volatility and shoot for a big return to try to get that big payoff. The usual 20%-of-profit, with a low or no hurdle rate, is also a call option, but it is closer to at-the-money and is less sensitive to the volatility of the underlying and is on only one-fifth of the profits, rather than all of them. There is less incentive to take on excess volatility. I think it works better in aligning the investor's and manager's interests. Schindler Trading charges a 2% management fee and 20% of new profits with a highwater mark and no hurdle rate. We don't receive any portion of the commissions paid. CTA's that get compensation from commissions have an incentive to churn, so I would frown on it as an investor. Aaron Schindler Schindler Trading
Just a question concerning the maxdrawdown, what kind of maxdd is used by real fund managers when reporting performance : maxdd computed on a closed trade basis only or taking into account the maximum adverse excursion of open trades (and if this is the case what is the minimum time frame used to take "snapshots" of the open maxdd) ?
Thanks for your answer. One month between each snapshot is not very accurate (maxdd minimized) but if open trades are included this is at least not misleading. This explains also why someone who wants to become a portfolio/fund manager must have a very long track record ...
Here's http://www.nuclearphynance.com/Show Post.aspx?PostIDKey=4851&PageIndex=10 the "M1Kz" answer: "DD of Rentec depends on time period, they really started performing around 1990 (eg Sharpe less than one until then) and the dd at the end of April 1989 was -25.5%. From 1990 to 1999 the worst dd occured at the end of March 1992 at -14.36%. From March 1992 to September 1999 the worst dd was -6.06% at the end of November 1994. From September 1999 and forward I do not know the magnitude of the worst dd."
This raises a new question If you have several DD in a row (several consecutive months with negative return) , is the maxdd the cumulative dd or the max of each individual monthly dd ?
Not exactly either. Here is a spreadsheet with a sample of how this is calculated. It's not just the sum of the drawdown months.
I'm not sure about the securities world, but in commodities (I'm a CTA) I was told by the NFA this is how you have to do it.
For CTA's the NFA requires the drawdown to be listed in the ddoc. This is how the NFA words it in their guide to ddocs: "The disclosure of the past performance of the offered trading program must also include...the worst peak-to-valley draw-down experienced by the trading program during the most recent five calendar years and year-to-date, as well as the period the draw-down occurred. The period begins with the peak month and year and ends with the valley month and year." Aaron Schindler Schindler Trading