Which rate must a hedge fund earn before the manager can take an incentive fee?

The correct answer, hurdle rate, refers to the minimum required rate of return that a hedge fund must achieve before the manager is eligible to receive any incentive fees. This mechanism helps to align the interests of the fund manager with those of the investors. If the fund does not achieve the specified hurdle rate, the manager cannot take a percentage of the profits as a fee, ensuring that investors do not pay for performance that does not exceed this benchmark.

The hurdle rate is often set as a fixed percentage, reflecting a threshold for performance, which encourages managers to generate sufficient returns for their clients. This structure can motivate managers to exceed a certain level of performance instead of merely aiming for a positive return, creating an environment where both parties benefit from strong investment performance.

In contrast, other concepts such as high-water mark refer to the highest value that the fund has previously achieved, ensuring that managers do not earn incentive fees on returning to a previous high after periods of loss. First-order risk pertains to risk assessments in investments and does not directly relate to incentive fees. Whipsaws refer to market conditions where prices swing rapidly in both directions and are unrelated to the fee structures for hedge funds. Understanding the role of the hurdle rate in the context of hedge fund performance highlights its