By Jamie Walters of FCI
A subscriber has written the following response to my ealier blog on how we calculate management and incentive fees in OSS and CPP. He writes “Thanks for the effort in explaining this but where did the $42 go in the CPP example? How can the starting balance in month 2 be $51,875 if the $42 was debited from the account? Is it actually billed in arrears? Definitionally, isn’t “account equity” less all manner of fees including management fees? Perhaps I have missed something here.”
Please refer to the original blog. My response to the subscriber follows:
Good question. The management fee is not billed in arrears. The management fee is billed on the first day of the month. For example, the February management fee is billed on the first day of February.
How can the starting balance in month two be $51,875? We calculate the monthly return based on the end-of-month account balance, which we refer to as the previous period’s ending net asset value (ENAV). All performance information is calculated on an accrual basis of accounting in accordance with generally accepted accounting principles. The beginning net asset value (BNAV) for the period shall represent the previous period’s ending net asset value (ENAV).
For an account that has just opened, we calculate the monthly return based on the BNAV. We do not subtract out the management fee that is billed on the first of the month to arrive at the BNAV. However, the ENAV for the first month will have the management fee deducted from it.
So in the CPP example that you are referring to in the blog, we calculate a 5% return before incentive fees as ($52,500 – $50,000) / $50,000. The account started with a $50,000 balance. This is the BNAV. The account ended with a $52,500 balance before incentive fees. That is how in the example, we have ($52,500 – $50,000) / $50,000. The $52,500 reflects the management fee that has been debited at the beginning of the period.
From $52,500, we debit the incentive fee for the period. In the example, the incentive fee was $625. This leaves a balance of $51,875 (=$52,500-$625), which is the ENAV.
By definition the ENAV for the period shall represent the BNAV plus or minus additions, withdrawals and redemptions, and net performance. Additions include both voluntary and involuntary additions. Withdrawals include both voluntary and involuntary withdrawals. Redemptions include both voluntary and involuntary redemptions. The net performance for the period represents the change in the net asset value net of additions, withdrawals, redemptions, fees and expenses.
Also, be aware that the return to the client is calculated as (ENAV – BNAV) / BNAV. In our hypothetical example, the return to the client is 3.75% (= $51,875 – $50,000) / $50,000, whereas the return before incentive fees was 5%. Just to be clear, the client would have seen a return of 3.75% net of all fees, not a return of 5%.
FCI would like to bring to your attention that there are substantial risks involved in trading futures and options on futures. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The volatile nature of the futures and high degree of leverage used in commodities may result in clients losing more than their original investment. Please consider carefully whether futures or options are appropriate to your financial situation.