Answer-first summary for fast verification
Answer: Proportional adjustment clause allows the hedge fund manager, in the event of style drift, to replace the fund's benchmark, ex-post, in order to reduce the funds reported tracking error
The **inaccurate** statement is **D**. - **A is true**: a *hurdle rate* is the minimum return a hedge fund must achieve before an incentive fee is charged. - **B is true**: a *high-water mark* means the fund must recover prior losses before the manager can earn an incentive fee again. - **C is broadly true in concept**: a *clawback* provision allows investors to recover previously paid incentive fees if later losses occur; the wording here is a bit loose, but the idea is that prior incentive compensation can be offset or returned. - **D is false**: a *proportional adjustment clause* is not meant to let the manager change the benchmark **ex-post** simply to reduce reported tracking error. The clause is intended to address changes in the fund's style or mandate in a way that keeps performance comparisons meaningful, not to retrospectively manipulate the benchmark. Therefore, the incorrect choice is **D**.
Author: Manit Arora
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Q-706.2. Hedge fund fees are notoriously high, although recently, the traditional "2 and 20" fee structure has been under much pressure. Clauses in fee structure agreements can help make the incentive fees more palatable for clients. In regard to these fee structure agreement clauses, each of the following is a true description EXCEPT, which is inaccurate?
A
Hurdle rate is the minimum return necessary for an incentive fee to be applicable
B
High-water market requires previous losses to be recouped before an incentive fee is applicable
C
Clawback refers to investors being able to use some (or all) previous incentive fees, held in a recovery account, to offset current losses
D
Proportional adjustment clause allows the hedge fund manager, in the event of style drift, to replace the fund's benchmark, ex-post, in order to reduce the funds reported tracking error
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