hurdle rate
The minimum rate of return required before a fund manager begins collecting performance fees, protecting investors from paying fees on mediocre returns.
Example
“With an 8% hurdle rate, the private equity firm only collected carried interest on returns above 8%.”
Memory Tip
HURDLE rate = minimum return before fees kick in. The manager must JUMP this hurdle.
Why It Matters
Understanding hurdle rates helps you evaluate whether a fund manager is truly earning their performance fees or simply meeting basic market expectations. This protects your investment returns from being reduced by fees paid for ordinary performance that you could achieve with a low-cost index fund.
Common Misconception
Many investors assume that any positive return means the fund manager deserves performance fees, but hurdle rates establish that the manager must exceed a predetermined benchmark before fees apply. This means a fund returning 5 percent in a year when the hurdle rate is 7 percent would not trigger any performance fee, even though the fund made money.
In Practice
A hedge fund might set a hurdle rate of 5 percent annually, meaning the manager only collects a 20 percent performance fee on gains above 5 percent. If the fund returns 12 percent in a year, the manager earns fees only on the 7 percent excess return, not on the full 12 percent return, aligning the manager's interests with beating the baseline threshold.
Etymology
HURDLE (obstacle to clear) RATE (percentage threshold). A RATE (threshold) the manager must HURDLE over to earn fees.
Common Misspellings
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See Also
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