Performance Fee Crystallisation After a Large Redemption
A fund has a 20% performance fee crystallised annually on 31 December, subject to a high-water mark. The high-water mark is 1.20 per unit; today's NAV is 1.38. On 15 November a single institutional investor holding 30% of units redeems in full. The fund's deed is silent on equalisation. The finance team calculates the fee on 31 December on the whole fund's gain above the high-water mark, which would charge all remaining investors for gains that partly belong to the departing investor. The fund's auditor has flagged the issue. The CEO wants to book the fee as calculated to protect revenue, but the compliance officer says paying it would breach the duty to act in unitholders' interests. Crystallisation is six weeks away.
1. Is the finance team's calculation consistent with fair treatment of unitholders? Explain.
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No. The fee should not be calculated on the whole fund's gain when 30% of the units left on 15 November. Without equalisation, the departing investor exits at 1.38 without paying a performance fee on its gain, and the remaining investors bear a fee on gains they did not earn. That is cross-subsidy and is inconsistent with acting in unitholders' interests. The deed being silent does not authorise an unfair result; it means the firm must adopt a defensible method, such as equalisation credits or series accounting, or crystallise the fee on the redeeming investor at redemption. The CEO's revenue concern cannot override fair treatment. The auditor's flag is serious and should be resolved before 31 December, with legal and trustee input. If the calculated fee has already been accrued, it should be adjusted or reversed.
2. What practical steps should be taken before 31 December?
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Before 31 December: calculate the fee under the current method and under an equalisation or series method; quantify the cross-subsidy. Ask legal whether the deed permits equalisation or a redemption-time crystallisation; if not, seek trustee approval and consider investor disclosure or approval for a policy change. Apply the chosen method consistently, document the rationale and have the auditor review it. If the departing investor can still be charged, issue an equalisation credit or adjustment; if not, reduce the fee so remaining investors are not overcharged. Communicate to the board and affected investors. Also review prior redemptions for the same defect and correct any recurring error. The objective is a fee that reflects each investor's own gain, not the fund's aggregate gain.