I donít know whether I have confused myself as this seems very easy, so seeking the help of people that might be able to explain things better for me!
I am trying to set up some calculations surrounding an Internal Rate of Return ... Or, I think I need an IRR calculation to solve a question....
The question is in relation to calculating returns of an investment share portfolio and calculating possible performance fees.
The benchmark outperformance calculation is fine and I am using a Time Weighted Return (TWR); but there is a technicality/criteria that needs to be met by the portfolio for any performance fees to be allowable...... and I am getting confused between two statements and if they mean the same thing or not, and whether or not i need to change my math to match a statement. Currently I am doing an IRR.
Basically, I had this first statement made to a client (the way I think it should be technically done):
***If at the end of any Performance Period the value of your portfolio is lower than your base invested amount, no performance fee shall be payable.
The base invested amount will be your initial investment amount if there have been no contributions or withdrawals. The value of your portfolio for a period must be above this initial investment amount or no performance fee shall be payable. If there have been any contributions or withdrawals at any time, an Internal Rate of Return (IRR) for your portfolio from inception will be used to determine if performance fees shall be payable, where a negative IRR will mean no performance fee shall be payable***
But then, somebody looked over the above statement and said that it was way too complicated and that the next statement will give you the exact same outcome:
***If at the end of any Performance Period the value of your portfolio is lower than the total value of your contributions less the total value of your withdrawals no performance fee shall be payable.***
So - are those two statements the same? Is using an IRR making things way over too complicated I feel that saying if "your portfolio is lower than the total value of your contributions less the total value of your withdrawals" that does not seem correct or the same as saying that your portfolio has a negative IRR, or at least, in certain situations will give wrong results?
Basically the issue comes, as I understand it, when there has been money put in and taken out AND there actually has been investment performance. I don't want to screw the portfolio manager out of performance fees nor do I want to make things unfair for the client where they may be charged when they should be.
The above situation may be a rare event, but basically the client should not be charged any performance fee (even if there is out-performance over a benchmark e.g. portfolio goes down, but benchmark goes down a lot more), there can be no performance fees charged if the clients portfolio is going backwards or is negative to what they have invested.
Obviously if they have only put in initial capital, then that is easy as whatever their starting portfolio value was, that is the minimum value allowable for the portfolio to be at that will allow any performance fee .Ö. But how do you determine if their portfolio is going backwards or not if they have put money in, taken money out etc.
Hope that makes sense!
Thank you for any insight and help