Answer-first summary for fast verification
Answer: 3.60%
Compute the return in two stages: 1. **Each hedge fund's net return after its fees** - Fund 1: \(-3\% - 1\% = -4\%\) → no incentive fee, so net = **-4%** - Fund 2: \(1\% - 1\% = 0\%\) → no incentive fee, so net = **0%** - Fund 3: \(11\% - 1\% = 10\%\) → incentive fee = 20% of 10% = 2%, so net = **8%** - Fund 4: \(21\% - 1\% = 20\%\) → incentive fee = 20% of 20% = 4%, so net = **16%** 2. **Average net return of the four hedge funds** \[ \frac{-4\% + 0\% + 8\% + 16\%}{4} = 5\% \] 3. **Fund of funds fee** - Management fee = 1% - Return after management fee = \(5\% - 1\% = 4\%\) - Incentive fee = 10% of 4% = 0.4% - Final return to investors = \(4\% - 0.4\% = 3.6\%\) So the nearest answer is **B. 3.60%**.
Author: Manit Arora
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Q-706.1. A fund of funds divides its money equally between four hedge funds who earn -3.0%, +1.0%, +11.0%, and +21.0% before fees in a particular year. The fund of funds charges "1% plus 10%", and the hedge funds charge "1% plus 20%" (due to competitive pressures, this is reduced from "2% plus 20%"). The hedge funds' incentive fees are calculated on the return after management fees. The fund of funds incentive fee is calculated on the net (after management and incentive fees) average return of the hedge funds in which it invests and after its own management fee has been subtracted. Which is nearest to the return to investors in the fund of funds? (please note this is inspired by Hull's EOC Question 4.17)
A
1.40%
B
3.60%
C
5.00%
D
7.50%
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