A fund of funds divides its money equally between five hedge funds that earn a gross return of -3%, -1%, 5%, 8%, and 10% before fees in a particular year. The fund of funds charges 1% plus 10% and the hedge funds charge 1.5% plus 15%. The hedge funds' incentive fees are calculated on the return after management fees. The fund of funds' incentive fee is calculated on the net (after management fees and incentive fees) average return of the hedge funds in which it invests and after its own management fee has been subtracted.

a) What is the overall return on the investments? [3 marks]

b) How is the overall return divided among the fund of funds, the hedge funds, and investors in the fund of funds? [7 marks]

Now, assume that the fund of funds invests a weight of 15%, 20%, 10%, 35% and 20% in the 5 different hedge funds above that deliver exactly the same gross returns listed above, respectively -3%, -1%, 5%, 8%, and 10% before fees in a particular year. Moreover, assume that the hedge fund incentive fees only apply above a hurdle rate of 3%. The fund of funds incentive fee still has no hurdle rate and is still calculated on the net (after management fees and incentive fees) average return of the hedge funds in which it invests and after its own management fee has been subtracted. c) What is the overall return on the investments? [3 marks] Page 4 ECOM055 (LSR 2020) Queen Mary, University of London, 2020 d) How is the overall return divided among the fund of funds, the hedge funds, and investors in the fund of funds?