AIFMD II lists the redemption fee among the liquidity tools but does not say how to set the range. The fund's own liquidity slices do.
Set the range from the fund's own liquidity cost curve: the bottom of the range is the average cost of meeting a normal dealing day from the cheapest liquidity, and the top is the average cost of meeting redemptions up to the level where the fund's second tool, typically a gate, takes over. On an illustrative 400 million open-ended credit fund gated at 10 per cent of NAV, that gives a range of 0.40 to 1.44 per cent. A flat 0.75 per cent fee overcharges on quiet days and leaves the investors who stay 276,000 short on a day that reaches the gate.
Worked in full in The AIFMD II Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Under AIFMD II the manager of an open-ended AIF generally has to select at least two liquidity management tools from points 2 to 8 of the list in Annex V of the Directive, as amended by Directive (EU) 2024/927, and a redemption fee is one of them. Annex V describes it as a fee, within a predetermined range that takes account of the cost of liquidity, paid to the fund by redeeming investors so that the investors who remain are not unfairly disadvantaged. The text does not say how to set the range. The arithmetic below is one defensible way to do it, and the one a supervisor can follow.
| Slice of NAV redeemed on one dealing day | Met from | Cost of the liquidity | Amount |
|---|---|---|---|
| 0% to 2% | Cash buffer, rebuilt from liquid bonds | 0.40% | 8 million |
| 2% to 6% | Liquid bonds, with market impact | 0.90% | 16 million |
| 6% to 10% | Sale of tradable loans | 2.50% | 16 million |
| Above 10% | Not met on the day: redemption gate |
Two design choices sit behind the table. The cash buffer is not treated as free: whatever cash pays a redemption has to be rebuilt by selling bonds, so even the first slice carries the bond cost. And the gate is the fund's second tool, which caps the redemptions the fee ever has to price at 10 per cent of NAV, 40 million.
The cost of a dealing day depends on the aggregate redemptions, not on any one investor's order. For each possible level of aggregate redemptions, cost the slices it consumes and divide by the amount redeemed.
Average cost at R = (cost of each slice used × amount drawn from it) ÷ total redeemed
At the gate, R = 10%, 40 million: 8 × 0.40% + 16 × 0.90% + 16 × 2.50% = 32,000 + 144,000 + 400,000 = 576,000
576,000 ÷ 40 million = 1.44%
In Excel, with slice widths (as % of NAV) in B2:B4, slice costs in C2:C4 and the day's redemptions (as % of NAV) in E1, put the amount drawn from each slice in D2 as =MAX(0,MIN($E$1-SUM(B$1:B1),B2)), fill down, and take =SUMPRODUCT(C2:C4,D2:D4)/E1.
| Aggregate redemptions (% of NAV) | Amount | Liquidity cost | Fee rate that covers it | Flat 0.75% fee | Flat fee less cost | Effect on remaining investors (bp) |
|---|---|---|---|---|---|---|
| 1% | 4 | 16,000 | 0.40% | 30,000 | 14,000 | 0.4 |
| 2% | 8 | 32,000 | 0.40% | 60,000 | 28,000 | 0.7 |
| 4% | 16 | 104,000 | 0.65% | 120,000 | 16,000 | 0.4 |
| 6% | 24 | 176,000 | 0.73% | 180,000 | 4,000 | 0.1 |
| 8% | 32 | 376,000 | 1.18% | 240,000 | −136,000 | −3.7 |
| 10% | 40 | 576,000 | 1.44% | 300,000 | −276,000 | −7.7 |
The range written into the fund documents is therefore 0.40 per cent to 1.44 per cent, with the schedule above as the rule for choosing a rate inside it on a given dealing day. The flat alternative fails at both ends: on a quiet day it charges a leaving investor almost twice the cost, and on the days that matter it recovers about half, so the remaining investors fund the rest. In basis points of NAV the shortfall looks small, 7.7 at the gate, but it recurs on every stressed dealing day, and it falls on precisely the investors the tool exists to protect.
Because the rate depends on aggregate flows, the same order costs different amounts on different days. An investor redeeming 5 million pays 20,000 on a 2 per cent day and 72,000 on a day that reaches the gate. That is the intended behaviour, and the documents should say so plainly, since the investor cannot know the aggregate when it submits its order.
The schedule is only as good as the cost estimates, and those widen in a stress. If loan sales cost 4 per cent rather than 2.50, the top of the range moves to 2.04 per cent; if bonds also widen, higher still. Two practical consequences follow. The top of the range should be set on stressed costs, not normal ones, because it is the stressed day it has to cover. And the range has to be reviewed with the liquidity profile, the same exercise as the Annex IV portfolio liquidity profile, so that the slices in the first table are the fund's actual ones.
Setting the top of the range at the marginal cost of the least liquid slice. At the gate the loans cost 2.50 per cent to sell, but only the last 4 per cent of NAV is met from them. Charging 2.50 per cent on the whole 40 million collects 424,000 more than the liquidity costs, 1.06 points too much, and transfers it from leaving investors to staying ones. That is the mirror image of the dilution the tool is meant to prevent, and it is hard to defend as a fee that "takes account of the cost of liquidity".
The other is confusing the tool with its neighbour. Under Annex V an anti-dilution levy compensates the fund for the cost of liquidity caused by the size of a particular subscription or redemption; the worked version is in how an anti-dilution levy is calculated. A redemption fee is a schedule fixed in advance. Choosing between them is a policy decision, and the policy should say why.
Build the cost curve from the liquidity slices, average it at each level of aggregate redemptions up to the gate, and write the range from the quiet-day cost to the gate-day cost: here 0.40 to 1.44 per cent. Then test the schedule on stressed costs. The liquidity buckets, the facility and the reverse stress level that sit behind a credit fund's tools are worked in the free workbook for this case.
Yes. Redemption fees are one of the tools listed in Annex V of the Directive, from which the manager of an open-ended AIF must generally select at least two. The fee is paid to the fund, not to the manager, and is set within a predetermined range that takes account of the cost of liquidity. In the illustrative case that range is 0.40 to 1.44 per cent.
Because the fund's liquidity cost depends on how much it must raise that day. In the illustrative fund the first 8 million of redemptions cost 0.40 per cent to meet, but reaching the 40 million gate costs 1.44 per cent on average. An investor redeeming 5 million therefore pays 20,000 on a quiet day and 72,000 on a gate day.
It is wrong at both ends. In the illustrative case a flat 0.75 per cent fee collects 60,000 against a cost of 32,000 on a 2 per cent redemption day, and 300,000 against 576,000 on a day that reaches the 10 per cent gate. The shortfall of 276,000, 7.7 basis points of remaining NAV, falls on the investors who stay.
This article is one calculation from The AIFMD II 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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