A performance report stops at the fund's own fees. What it does not show is the tax, which is settled on your return rather than the manager's, or the compounding lost on both. This measures the whole distance between the two numbers.
Open the instrumentNothing is transmitted and nothing is stored. No figure here is a claim about any fund.
The first is what the strategy earned. The second is what the fund reports. The third is what the investor keeps. They are rarely close together, and the distance between the second and the third is the part nobody sends you.
A fund's net performance is stated after its management and incentive fees. That is the number in the tearsheet, the number in the consultant's database and the number in the board pack. It is a real number and it is computed honestly. It is also computed before the investor's own tax, because the fund does not know the investor's rates, and it is reported on the fund's return rather than on the wealth of the person who owns the units.
For most of the equity market that gap is modest, because most of the return is unrealised appreciation that is not taxed until someone sells. For a strategy that turns its book over several times a year and holds almost nothing long enough to qualify for the preferential rate, the gap is not modest. The same return, earned by two managers with identical fee schedules, can leave the two investors in materially different places purely because of when and at what rate it was taxed. That is an arithmetic result rather than an opinion, and it is what this instrument computes.
The purpose here is measurement, not advocacy. A fund whose economics survive this examination will show that plainly; one whose do not will show that just as plainly. The character of an alternative's return, and why it matters more than its headline, is the subject of Alternative Investment Intelligence above this page. This page does the sum.
Enter the fund's terms and your own rates. The four scenarios are shapes rather than funds — sets of stated assumptions chosen to isolate one variable at a time — and everything in them is editable. Negative returns are accepted.
The tax layer is the same engine used by the Portfolio Tax Drag Calculator, the Wealth Simulator and PPLI Break-Even. There is one model of after-tax compounding on this site, not four; the fee waterfall on top of it is specific to this page because an incentive fee cannot be expressed as an annual rate.
Each year runs in a fixed sequence, and the sequence matters because every step is charged on what the step before it left behind.
gross P&L = value × gross return
management = value × management fee (on the opening value)
pre-incentive = value + gross P&L − management
incentive = rate × profit above the mark (see below)
net of fees = pre-incentive − incentive
taxable = net of fees − value + non-deductible fees
tax = income × income rate + realised gains × gains rate
value = net of fees − tax
The management fee is charged on the value at the start of the year, so it is paid whether the fund makes money or not and it is not reduced by a loss. The incentive fee is charged on the profit remaining after the management fee has been taken, which means a fund quoting twenty per cent is charging twenty per cent of a smaller number than its gross return — a distinction that flatters the fee schedule and is almost never spelled out.
A hurdle is a return the fund must clear before any incentive is charged, and the model implements both forms because they are not close to equivalent. A hard hurdle charges only on the excess above it. A soft hurdle, once cleared, charges on the whole profit as though the hurdle were not there. On the default assumptions a six per cent hard hurdle raises the reported return from 6.40% to 7.60% and cuts the incentive fee over twenty years from $3,380,408 to $1,287,282; the same six per cent as a soft hurdle changes nothing at all, because the fund clears it every year. Which of the two a document describes is worth reading carefully.
A high-water mark means the manager charges nothing until the fund exceeds its previous peak, so a loss has to be earned back before the incentive resumes. Turning it off charges each year on its own gain from that year's opening value. On a monotonically rising path the two are identical; on any path with drawdowns they are not, and the difference does not appear anywhere in the quoted rate.
The year's economic result is split into income and appreciation by the income share entered. Income is taxed as it arises, at a blend of the ordinary and preferential rates set by how much of it is ordinary. Appreciation is taxed only to the extent turnover realises it, at a blend set by the short-term share; whatever is not realised accumulates as unrealised gain and raises the eventual settlement instead. Losses carried forward are applied against later realised gains before income. A loss year produces no current benefit: capital losses offset capital gains and only $3,000 of the excess reaches ordinary income under 26 U.S.C. §1211(b), which is immaterial at these amounts, so the realised portion is carried forward under §1212(b) and nothing is credited in the year of the loss.
This is a real fork and the model does not pick a side. Where a fund is characterised as an investor rather than a trader, its management fee is a miscellaneous itemised deduction, and 26 U.S.C. §67(g) allows none for taxable years beginning after 2017; §67(c) prevents the deduction being taken indirectly through the partnership. The investor then pays the fee and is taxed on a gain measured before it. Where the fund's activity is a trade or business, the expense falls under §162 and is deducted. An incentive taken as a profit allocation reduces the investor's distributive share and so reduces taxable income either way, which is a substantial part of why incentives are commonly structured as allocations rather than as fees. Both controls are exposed; on the default assumptions the difference between them is $707,762 of tax and $1,496,388 of terminal wealth.
Tax is paid out of the investment, consistent with the other instruments on this site, so a dollar paid in year three is a dollar that does not compound for the remaining seventeen. The decomposition separates that effect from the payments themselves: fees paid, tax paid, and the return those two would have earned had they stayed invested at the gross rate. The four deductions and the retained figure sum to the gross benchmark exactly, in every case including funds that lose money — where the compounding term correctly turns negative, because money taken out early did not fall with the fund.
Seven things worth knowing before the output is used for anything.
The fund earns its stated gross return every year. There is no volatility and no sequence of returns, which matters more here than in a simple projection: the high-water mark and the loss carryforward are both path-dependent, and a smooth path understates what each is worth. A fund with the same average return and a rougher path pays more in incentive fees, not less.
Diversification, correlation and the effect of this position on everything else are outside it. For the portfolio question — what the whole allocation loses to tax each year, sleeve by sleeve — the Portfolio Tax Drag Calculator is the instrument.
Every input is supplied by the reader. The four scenarios are named for the shape of the assumptions they contain, not for any manager, strategy category or industry average. Fee terms in particular vary widely between managers and have moved over time, and nothing here should be read as a market rate.
An actual partnership return allocates interest, dividends, short-term gains, long-term gains, section 1256 contracts, foreign items and expenses separately, and the timing of the schedule itself is often late. The model reduces all of that to an income share, an ordinary share of that income, a turnover figure and a short-term share. That is enough to size the drag and not enough to prepare a return.
It is added to both federal rates rather than modelled separately. Its deductibility, its treatment of capital gains where that differs, and any minimum tax are specific to the taxpayer and to the year, and folding them in would give the output a precision it has not earned.
Gates, side pockets, lock-ups, redemption notice periods, equalisation methods for investors entering mid-year, and the difference between series and equalisation accounting all affect what an individual holder actually receives. So does leverage at the fund level. None of it is here.
A strategy that survives this arithmetic is not thereby a good investment, and one that does not is not thereby a bad one. Whether the gross return assumption is realistic is the question that matters most, and it is the one question no model can answer.
Ten million dollars, twenty years, ordinary rate 40% and long-term 25%, management fee not deductible, incentive taken as an allocation, position settled at the end. Two strategies, each with the fee terms stated beside it.
| Lower turnover 1.5 and 20 | High turnover 2 and 20 | |
|---|---|---|
| Gross return | 9.00% | 12.00% |
| Turnover / short-term share | 35% / 10% | 100% / 90% |
| Reported net return | 6.00% | 8.00% |
| After-tax return | 4.78% | 4.61% |
| Fee drag | 300 bps | 400 bps |
| Tax drag | 122 bps | 339 bps |
| Gross result at 20 years | $56,044,108 | $96,462,931 |
| Value on the fund's own reporting | $32,071,355 | $46,609,571 |
| Retained by the investor | $25,452,329 | $24,607,134 |
| Share of the gross result retained | 34% | 17% |
The second fund is better on every number anyone publishes. It earns three percentage points more gross and reports two percentage points more net — 8.00% against 6.00% — and on the fund's own reporting it turns ten million dollars into $46.6 million against $32.1 million. A consultant's database would rank it comfortably ahead. An investment committee comparing the two on net performance would not find the decision difficult.
The investor ends up with less money. $24,607,134 against $25,452,329, because the strategy realises everything it earns each year and nine tenths of those gains are short-term, so they are taxed at 40% as they arise rather than deferred and taxed at 25% at the end. The first fund keeps 34% of its gross economic result for the person who owns it. The second keeps 17%. The gap between the two reported numbers is 200 basis points in the second fund's favour; the gap between the two retained numbers is 17 basis points the other way.
Nothing in that is a criticism of the second strategy, which earned a third more than the first. It is a statement about who received the difference. Of the $96.5 million of gross economic result, $10.2 million went in fees, $13.1 million went in tax, and $48.5 million was never earned at all because the money paid out along the way stopped compounding. The investor's share was what was left.
Two smaller results from the same page are worth stating because they are checkable. A six per cent hard hurdle on the conventional 2-and-20 case raises the reported return from 6.40% to 7.60% and takes $2.1 million off the incentive fee over twenty years. The same six per cent as a soft hurdle changes nothing whatsoever, because a fund earning ten per cent gross clears it every year and is then charged on the whole profit anyway. And treating the management fee as deductible rather than not — the trader-versus-investor characterisation, which is a question of fact about the fund and not a choice the investor makes — is worth $707,762 of tax and $1,496,388 of terminal wealth on otherwise identical assumptions.
Three provisions do the work in the tax layer. They are cited because the model applies them, not to characterise any particular fund.
Subsection (g) provides that, notwithstanding the two-per-cent floor in subsection (a), no miscellaneous itemised deduction shall be allowed for any taxable year beginning after 31 December 2017. Subsection (c) directs that regulations prohibit the indirect deduction through pass-through entities of amounts that would not be deductible if paid directly by an individual. Together they are why a management fee borne through an investor fund may reduce wealth without reducing taxable income. Whether a given fund is an investor or a trader, whose expenses fall under §162 instead, is a question of fact. Read the section.
For a taxpayer other than a corporation, losses from sales or exchanges of capital assets are allowed only to the extent of gains from such sales or exchanges, plus the lower of $3,000 or the excess of those losses over those gains. The remainder carries forward. The model carries the realised portion of a loss forward against later gains and credits nothing in the year of the loss, which is the correct shape at these amounts even though it ignores the $3,000. Read the section.
The definitions that separate short-term from long-term capital gain and loss by reference to whether the asset was held for more than one year. This single distinction, applied to a strategy that realises most of what it earns each year, accounts for more of the gap between reported and retained than the entire fee schedule does in several of the scenarios on this page. Read the section.
On what is deliberately absent: no carrier, fund or industry figure appears anywhere on this page. Fee terms are commonly discussed by reference to two per cent and twenty per cent, but actual terms vary widely between managers and have moved over time, and this page treats that convention as a starting point to be replaced rather than as a fact. Where a claim would require data nobody publishes, the input is left to the reader instead.
Bring the fund documents and the K-1 character. Read personally by a senior specialist, with a written reply usually within one business day.
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