turns for three months are listed for the individual funds. Each return
is before management fees and incentive fees. Assume for simplicity
that each hedge fund charges an annual management fee of 2 percent
and an incentive fee equal to 20 percent of returns (after management
fees have been deducted). Also, assume that the fund of funds charges
a management fee of 0.5 percent annually and an incentive fee of 10
percent of return (after individual fund fees and fund of funds man-
agement fee).

What is the average return on the fund of funds?
3.10 If an institutional investor replicated the four strategies, but imple-
mented the strategies in-house and paid no management or incentive
fees, from question 3.9, what would be the net return on the assets
committed to the four hedge funds?
3.11 Assume that a single hedge fund manager created and ran the four
strategies in questions 3.9 and 3.10 and charged a management fee of
2 percent and incentive fee of 20 percent. If the manager had decided
to combine the strategies into a single hedge fund, what would be the
performance on that fund?
3.12 Explain the differences in the average return between the three sce-
narios.
NOTES
1. These securities regulations also include definitions thresholds for institutional
investors not described here.
2. For simplicity, ignore the additional rate reduction for gains on assets held
longer than five years that recently complicated the tax code.
3. For example, Mark Hurley at Undiscovered Managers, quoted in "1999
CFP Master's Retreat in Squaw Valley, California," Journal of Financial
Planning, January 2000 (www.fpanet.org/journal/articles/2000_Issues/jfp
0100-art3.cfm).
4. Rob Hegarty, from the TowerGroup, quoted by Jim Middlemiss, "Number of
Wealthy on Rise," Registered Representative (online magazine), May 29, 2001
(http://registeredrep.com/ar/finance_number_wealthy_rise/index.htm).
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