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Do hurdle rates always reset at year end or crystallization?
Asked by Dara Brackman

If a fund under-performs the hurdle and pays out no incentive fees over a fiscal year end, will the hurdle rate reset? If a fund under-performs the hurdle and pays out no incentive fees over a crystallization period, will the hurdle rate reset? Is there a standard approach to either or both of the above or is it fund specific?

Answer By Nicholas Roman

I think there's some confusion on the difference in Hurdle rate and High-Water Mark. Take a look at the definition:

Hurdle rate-The minimum return necessary for a fund manager to start collecting incentive fees. The hurdle is usually tied to a benchmark rate such as Libor or the one-year Treasury bill rate plus a spread. If, for example, the manager sets a hurdle rate equal to 5%, and the fund returns 15%, incentive fees would only apply to the 10% above the hurdle rate.

High-Water Mark-A provision serving to ensure that a fund manager only collects incentive fees on the highest net asset value previously attained at the end of any prior fiscal year -- or gains representing actual profits for each investor. For example, if the value of an investor's contribution falls to, say, $750,000 from $1 million during the first year, and then rises to $1.25 million during the second year, the manager would only collect incentive fees from that investor on the $250,000 that represented actual profits in year-two.