The quarterly hurdle and catch-up of a semi-liquid private credit fund worked line by line, and why an income fee can take a third of a year's total return.
The income incentive fee of a semi-liquid private credit fund is usually 12.5 per cent of each quarter's pre-incentive net investment income, payable only above a hurdle of 1.25 per cent of NAV, with a full catch-up up to 1.4286 per cent. On an illustrative quarter earning 2.00 per cent, the fee is 0.25 per cent of NAV, 2.50 on every 1,000. Because losses are not part of net investment income, the same fee is paid in a quarter when the fund's NAV falls.
Worked in full in The Evergreen Fund Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Evergreen private credit funds and non-traded credit vehicles typically carry two incentive fees: one on income, paid quarterly, and one on realised capital gains net of losses, paid annually. The income fee is by far the larger, since a credit fund's return is mostly coupon. It is also the one investors most often misread, because the hurdle sounds like a return hurdle and is not.
| Line | % of NAV | Amount |
|---|---|---|
| Investment income, net of interest on borrowings | 2.60% | 26.00 |
| Management fee (1.25% a year) | −0.3125% | −3.125 |
| Other expenses | −0.2875% | −2.875 |
| Pre-incentive fee net investment income | 2.00% | 20.00 |
Hurdle h = 1.25% a quarter (5% a year). Catch-up ceiling = h ÷ (1 − 12.5%) = 1.4286%.
Income x ≤ 1.25%: fee 0.
1.25% < x ≤ 1.4286%: fee = x − 1.25% (all of it to the manager).
x > 1.4286%: fee = 12.5% × x.
Here x = 2.00%: catch-up 0.1786% + 12.5% × (2.00% − 1.4286%) = 0.0714%, total 0.25%, or 12.5% × 2.00% directly.
In Excel: =IF(x<=h,0,IF(x<=h/(1-r),x-h,r*x))
Net investment income after the fee is 1.75 per cent, 17.50 on 1,000. Once the catch-up is complete the hurdle has no further effect: above 1.4286 per cent the manager simply takes 12.5 per cent of everything.
| Income, % of NAV | Fee | Investor keeps | Fee share of income |
|---|---|---|---|
| 1.00% | 0.00 | 10.00 | 0.00% |
| 1.25% | 0.00 | 12.50 | 0.00% |
| 1.35% | 1.00 | 12.50 | 7.41% |
| 1.4286% | 1.79 | 12.50 | 12.50% |
| 1.75% | 2.19 | 15.31 | 12.50% |
| 2.00% | 2.50 | 17.50 | 12.50% |
| 2.50% | 3.12 | 21.88 | 12.50% |
Inside the catch-up band the investor's income is frozen at 12.50: every extra basis point goes to the manager. That is what "full catch-up" means, and why the band is narrow.
Now run four identical quarters of 2.00 per cent income, with credit losses of 3.00 per cent of NAV in the third quarter and 2.00 per cent in the fourth.
| Quarter | Income | Losses | Income fee | Net to investor |
|---|---|---|---|---|
| Q1 | 2.00% | 0.00% | 0.25% | 1.75% |
| Q2 | 2.00% | 0.00% | 0.25% | 1.75% |
| Q3 | 2.00% | −3.00% | 0.25% | −1.25% |
| Q4 | 2.00% | −2.00% | 0.25% | −0.25% |
| Year | 8.00% | −5.00% | 1.00% | 2.00% |
The fund returned 3.00 per cent before the incentive fee and 2.00 after it. The income fee took 1.00 point, 33.3 per cent of the total return, against a headline rate of 12.5 per cent. Nothing was miscalculated: the fee was designed on income, and the losses belong to the capital gains fee, which will simply not be paid until they are recovered.
Some funds add a lookback: the cumulative income fee over a trailing period may not exceed 12.5 per cent of the cumulative pre-incentive net return, losses included. Over this year the cap is 12.5% × 3.00% = 0.375 per cent, 3.75 on 1,000 instead of 10.00, and the investor's return rises from 2.00 to 2.625 per cent. In a year without losses the cap does not bind and the two fees are identical.
The quarterly test cuts both ways. Because each quarter is tested alone, lumpy income can fall below the hurdle in some quarters. Quarters of 3.00, 1.00, 3.00 and 1.00 per cent earn 8.00 per cent for the year, the same as above, but pay 0.75 per cent of fees instead of 1.00, since the two weak quarters miss the hurdle entirely. Some terms add a carry-forward of hurdle shortfalls; read which one applies before modelling.
The common mistake is to read the 5 per cent annualised hurdle as a return hurdle and conclude that a fund returning less than 5 per cent pays no incentive fee. The hurdle is on income only. A fund can return 2 per cent, or lose money, and pay a full income fee every quarter. When comparing evergreen credit funds, ask for the fee as a share of total return over a full cycle, and whether a total return cap is in the terms.
Compute the income fee quarter by quarter with the three-band formula, then compare the year's fees with the year's total return, not with its income. On these figures the headline 12.5 per cent became a third of the return in a year of credit losses. The full fee stack of a private credit interval fund is worked in what a private credit interval fund earns after fees, and the working documents on fees and fair treatment are on the free companion page for this book.
The band of income above the hurdle that goes entirely to the manager until it has received its full percentage. With a 12.5 per cent fee and a 1.25 per cent quarterly hurdle, the band runs from 1.25 to 1.4286 per cent of NAV, the hurdle divided by 0.875. At 1.35 per cent the manager takes 0.10 and the investor keeps 1.25; from 1.4286 per cent up the fee is 12.5 per cent of all the income.
Yes, unless the terms include a total return cap. The fee is measured on net investment income, which excludes realised and unrealised losses. In the illustrative year, 8.00 per cent of income and 5.00 per cent of losses give a 3.00 per cent total return, of which the income fee takes 1.00 point, 33.3 per cent.
It caps the income fee at the fee rate times the fund's cumulative pre-incentive net return, losses included, over a lookback period. In the illustrative year that cap is 12.5 per cent of 3.00 per cent, 0.375 per cent of NAV, instead of the 1.00 per cent the quarterly calculation produces: 6.25 saved on every 1,000 of NAV.
This article is one calculation from The Evergreen Fund Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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