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Answer: A clawback clause provides a mechanism for investors to reclaim incentive fees that have already been paid.
## Explanation **C is correct.** A clawback clause is a mechanism that allows investors to reclaim incentive fees that have already been paid to hedge fund managers if the fund subsequently suffers losses. This protects investors by ensuring that managers don't receive excessive compensation for temporary performance that later reverses. **A is incorrect** because this describes a hurdle rate, not a high-water mark. A hurdle rate requires the fund to achieve a minimum return threshold before incentive fees are paid. **B is incorrect** because this describes a high-water mark, not a hurdle rate. A high-water mark ensures that incentive fees are only paid on new profits above the previous highest net asset value. **D is incorrect** because a proportional adjustment clause relates to how the high-water mark applies to partial withdrawals, not to raising the hurdle rate based on profits. These fee structure adjustments were implemented to address investor concerns about the alignment of interests between hedge fund managers and investors, particularly the issue of managers receiving incentive fees for performance that may not be sustainable.
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An analyst at an investment firm is researching the fee structures at several hedge funds. The analyst notes that, in the past, incentive fees strongly favored hedge fund managers to the disadvantage of investors in the hedge funds, causing investors to be reluctant to invest in them. Many hedge funds have recently adjusted the terms they offer to attract new investors. Which of the following correctly describes one of these adjustments to the fee structure?
A
A high-water mark clause states that incentive fees will only be paid when returns are above a certain percentage return each year.
B
A hurdle rate states that incentive fees will only be paid when cumulative investor profits are positive and are above a specified amount.
C
A clawback clause provides a mechanism for investors to reclaim incentive fees that have already been paid.
D
A proportional adjustment clause provides a mechanism to raise the hurdle rate as the hedge fund generates more profits.