Help me understand NAV growth - quick question
Hi,
I have a quick question that's been bothering me about NAV/performance fee behavior.
Imagine a fund with a NAV of $1,000,000 and a 20% performance fee (ignoring expenses and the management fee for this example), funded entirely by one LP.
In Year 1, the fund achieves a 10% return, resulting in an ending NAV of $1,100,000, with $1,080,000 belonging to the LP and $20,000 allocated to the GP as a performance fee.
In Year 2, the fund achieves another 10% return. My question is: Does the GP's stake grow by the 10% return plus the performance fee allocation for that year, or does it grow only by the performance fee allocation for Year 2?
Intuitively, the first scenario feels correct (the GP's stake increases by the percentage return and the performance fee allocation). However, a colleague of mine who works in fund administration for private equity insists that only the performance fee/carry allocation growth is applied.
Could someone clarify this? Is this discrepancy due to different methodologies used in the private equity versus hedge fund world? Any insights would be greatly appreciated.
Based on the most helpful WSO content, here's what you need to know about NAV growth and performance fee behavior:
Year 1 Calculation:
Year 2 Calculation:
GP's Stake Growth:
This approach aligns with the methodology used in private equity, where the GP's compensation is based on the performance fee (carry) rather than a percentage return on the entire NAV. This might differ from hedge fund practices, where different fee structures and methodologies could apply.
For further insights, you can refer to the detailed discussions on WSO forums: - https://www.wallstreetoasis.com/forum/private-equity/for-seniors-who-ha…</a">For seniors who have spent your career in private equity, do you regret it?
This should clarify the discrepancy and provide a better understanding of how performance fees are applied in private equity.
Sources: For seniors who have spent your career in private equity, do you regret it?, Secondary PE Modeling, For seniors who have spent your career in private equity, do you regret it?, What Happens when a PE Fund Closes?, Why the hate towards growth PE / sourcing (e.g. KKR Tech)?
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The return is compounded based on the net.
Year 1:
Start NAV: $100
Say you achieve a 10% return
End NAV: $110
Assume 2/20 fees: 2% x 100 + 20% x 10 = 2 + 2 = 4
NAV Net of Fees = $110 - $4 = $106
Year 2:
Start NAV = $106 Say you achieve 10% return again End NAV = $116.6
NAV Net of Fees = $116.6 - $2.12 - 2.12 = $112.36
2 YR CAGR = [1+ (112.36 - 100)/100]^(1/2) - 1 = 6% annualized return
Recheck work: Year 1: 100 x 1.06 = $106 Year 2: 106 x 1.06 = $112.36
Also think about it logically, the client/investor in the fund is really only entitled to the NAV net of all expenses. So only the Net NAV gets compounded (assuming no inflows or outflows into the fund).
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