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CAIA Level I · Worked application

Hedge Fund Fees and Liquidity: A Worked Calculation

Calculate hedge fund fees in the order specified by the agreement, using the correct NAV base, hurdle and high-water mark. Separately check when an investor may request redemption and when cash is actually available.

The key decisions, at a glance

  • 1. Management fee

    Multiply the stated rate by the contract’s fee base.

    Watch for: Opening, ending and average NAV are different bases.

  • 2. Incentive fee

    Apply the hurdle and high-water mark in the specified order.

    Watch for: Do not automatically charge on all gross gains.

  • 3. Notice and lockup

    Check eligibility to request and the notice deadline.

    Watch for: Submitting a request is not the same as receiving cash.

  • 4. Gate and suspension

    Apply any contractual limit to the eligible amount.

    Watch for: Quarterly dealing does not guarantee full quarterly redemption.

Original worked case

Calculate a fee above a high-water mark

Given: Opening NAV is $100; gross ending NAV is $120. A 2% management fee uses opening NAV. A 20% incentive fee applies to NAV above a $110 high-water mark after the management fee. No hurdle or flows.

  1. 01 Management fee

    2% × $100 = $2; NAV becomes $118.

  2. 02 Eligible incentive gain

    $118 - $110 = $8.

  3. 03 Incentive fee

    20% × $8 = $1.60; ending NAV is $116.40.

Answer and interpretation

Net return is 16.40%. Charging 20% on the full $20 gross gain would ignore the high-water mark and fee order.

From gross value to investor value

$ per $100 invested · scale 0 to 120

From gross value to investor value; $ per $100 invested
ScenarioValue
Gross ending NAV120
After management fee118
After incentive fee116.4

Hypothetical fee waterfall. The vertical comparison starts at zero; exact values are shown.

Change one assumption

If post-management-fee NAV is $108, it is below the $110 high-water mark and this case has no incentive fee.

Independent teaching example with the stated assumptions. Not an official exam question, marking key or observed market trend.

Understand the method

Part 1

Write the fee sequence before inserting numbers

Start with opening investor NAV, subscriptions and withdrawals, and the period’s gross investment result. Identify the management-fee base and whether that fee is deducted before the incentive fee. Then establish the incentive hurdle, high-water mark and crystallization date. These contract choices can change the result even when two funds quote the same fee percentages.

A clean worksheet has a separate line for each adjustment. For example, 2% of opening NAV is not the same as 2% of closing gross NAV. Do not treat an incentive fee as 20% of the entire account unless the contract actually says so; it normally applies to an eligible profit base. State whether the example ignores intra-period subscriptions, equalization, taxes and other expenses.

Part 2

Track the high-water mark across a loss and recovery

A high-water mark generally prevents a manager from earning another incentive fee on recovery of previously lost value under the applicable terms. Track the investor’s relevant post-fee reference level rather than resetting the benchmark to a lower NAV after a loss. A subsequent positive return can still leave the account below its previous high-water mark and produce no incentive fee.

The exact treatment of subscriptions, withdrawals, share classes and resets can be more complex than a single-account illustration. Management fees may continue during recovery, so regaining the old gross asset value may not restore the old investor NAV. Calculate the pre-incentive value after the stated management fee, then compare it with the applicable reference level.

Part 3

A hard hurdle and a soft hurdle create different fees

Under a simplified hard hurdle, the incentive fee applies only to profit above the hurdle. Under a simplified soft hurdle, once the hurdle is exceeded the incentive fee applies to a broader profit base, often the whole profit. Catch-up provisions can create further variations. The label is insufficient unless the eligible base and sequence are specified.

Assume $100 opening NAV, $110 before incentive fees, no management fee and a 5% hurdle. A 20% hard-hurdle incentive is 20% × ($110 - $105) = $1, leaving $109. A soft hurdle applying to the full $10 profit produces a $2 fee, leaving $108. This comparison isolates the hurdle convention; it is not a universal contract interpretation.

Part 4

Convert redemption terms into a dated cash forecast

A lock-up restricts when redemption becomes possible. A dealing frequency states the available dealing dates. A notice period determines when a valid request must arrive. Settlement determines when proceeds are paid after the dealing date. Gates can limit the amount redeemed, and side pockets can retain exposure to selected assets. These terms address different stages of obtaining cash.

Suppose a fund deals quarterly, requires sixty days’ notice and pays thirty days after the dealing date. A request submitted thirty days before quarter-end may miss that quarter even though the investor describes the fund as quarterly liquid. Build the timeline using actual contractual calendar rules and possible gates. A portfolio spending obligation cannot safely rely on the shortest advertised interval.

Loss and recovery ledger: no management fee, 20% incentive above HWM

Start

Pre-incentive NAV
$100
Fee
None
Closing NAV / next HWM
$100 / $100

1: gain 20%

Pre-incentive NAV
$120
Fee
$4
Closing NAV / next HWM
$116 / $116

2: loss 25%

Pre-incentive NAV
$87
Fee
$0
Closing NAV / next HWM
$87 / $116

3: gain 40%

Pre-incentive NAV
$121.80
Fee
$1.16
Closing NAV / next HWM
$120.64 / $120.64

One continuing investor; annual crystallization; no flows, hurdle, taxes or other costs. The HWM does not fall after Year 2.

More worked practice

Original teaching cases. Use the stated assumptions; these are not official exam questions or marking keys.

A gate turns one redemption request into several cash dates

Given: An investor requests $30m. Assume the contract limits this investor’s payment to 10% of an unchanged $100m reference NAV per quarter and carries the remainder forward without priority changes.

  1. 1The illustrative quarterly limit is 10% × $100m = $10m.
  2. 2Only $10m of the first request is paid at the first settlement; $20m remains.
  3. 3With the same assumptions, two further quarterly payments are needed.

Interpretation: A dealing date is not a promise to pay the full request. Real gates may instead apply at the fund level, change with NAV and flows, or allow manager discretion, so read the actual agreement.

Check your understanding

Answer first, then open the explanation. These checks are original practice and do not generate an exam score.

1. After a loss, should the HWM automatically be reduced to current NAV?

No, not under the standard loss-recovery convention illustrated here. Lowering it would charge incentive fees again on recovery.

2. Why must a fee calculation state whether management fees come first?

The incentive-fee base can change after management fees. Different sequences produce different investor NAVs.

3. Is a 90-day lock-up the same as a 90-day notice period?

No. One limits initial eligibility; the other governs request timing. Both may apply, followed by a dealing date and settlement delay.

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Common questions

Is “2 and 20” enough to compute the net return?

No. You also need fee bases, timing, hurdles, high-water marks and cash-flow treatment.

Can the net asset value rise while access to cash is restricted?

Yes. NAV measures reported value. Lockups, notice periods, gates or suspensions determine liquidity under the agreement.

Sources and scope

The sources below establish their stated framework or subject context. Calculations and cases are our own teaching material; these sources do not endorse them or establish complete exam coverage.

By MiloPrep editorial team. Updated 10 October 2026. Independent study notes, not affiliated with or endorsed by CAIA Association. How we prepare our content.

Notes

  • * Study scope: Selected study concepts, not complete curriculum coverage. Match your sitting to the official exam-year materials; CAIA’s current resource page now links to 2027. ↩ Return to content