The hurdle rate in the context of fund management is a predefined benchmark that a fund must exceed before the manager can charge a performance fee. This benchmark can be a widely recognised rate like the London Interbank Offered Rate (LIBOR) or a fixed percentage. The concept behind the hurdle rate is to align the interests of the fund manager with those of the investors. By setting this rate, the manager is incentivised to not only generate positive returns but also to surpass a certain performance level, ensuring that investors are rewarded before the manager earns additional fees.
In funds where a hurdle rate is applied, the manager's performance fee is contingent on the fund’s annualised performance exceeding this rate. This arrangement serves as a safeguard for investors, ensuring that they do not pay performance fees for mediocre or below-benchmark results. It essentially stipulates that the manager must deliver a return higher than what could be achieved through an alternative, lower-risk investment. This structure is particularly appealing to investors who seek a balance between the potential high returns of active fund management and the protection against underperformance.
For investors, a fund’s hurdle rate is a critical factor to consider. It not only provides insight into the fund manager’s confidence in their ability to generate high returns but also offers a form of risk control. However, it is important to understand that a hurdle rate does not guarantee profits or protect against losses. It merely ensures that performance fees are aligned with superior performance. Investors should evaluate the hurdle rate in the context of the fund’s overall risk profile, investment strategy and their personal investment goals. It is one of many factors to assess when choosing a fund, alongside historical performance, management expertise and investment philosophy.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.