For Whom Hurdle Rate and High-Watermark Exist?

Abstract

In this study, we first conduct multinomial logistic regression analysis to see how hedge fund attributes affect hedge fund managers’ decision of whether to offer a hurdle rate and/or high-watermark. Hedge funds taking more risky position and collecting high performance fee are more likely to offer hurdle rate and/or high-watermark. Second, we conduct cross-sectional regression analysis to see how hedge fund attributes affect hedge fund performance. Our results indicate that hurdle rate and high-watermark are restrictions for hedge fund managers on collecting fee and that hurdle rate and high-watermark cannot be considered to be incentives. We also find that hedge funds collecting high performance fee and having large amount of funds are more likely to outperform those collecting low performance fee and having small amount of funds. While conducting cross-sectional regression analysis, we use three different measures of hedge fund performance: alpha, palpha and Sharpe ratio. Alpha and palpha are obtained from the optimal model by investment strategy controlling for hedge fund risk associated with risk factors different by its investment strategy. In addition, we control for survivorship and instant history biases. So, our results from alpha and palpha are more credible than those of Soydemir et al. (2012) which employs only Sharpe ratio.