What is Equalisation?
Equalisation is a means of ensuring that every investor is charged his/her fair share of performance fee based on how his/her own investment in the fund has performed.
If an investor subscribes for Participating Shares at a time when the current Gross Net Asset Value (GAV) per share is different from the Peak NAV per share or High Water Mark (HWM), adjustments called equalisation credits and deficits will be made to reduce inequities that could otherwise result to the subscriber or to the Investment Manager.
What is achieved with Equalisation?
Equalisation prevents effects such as Free Rides and Clawbacks. This is best illustrated by the below example.
"Amazing Fund" has a monthly valuation period and a quarterly performance period. Performance Fee rate = 20%
Investor A subscribes at $110/share.
Investor B subscribes at $90/share,
GAV=$120, Performance Fee = ($120-$100)*20%=$4/share $NAV=HWM=$116
If no equalisations are made, investor A will pay Performance Fee for the fund's NAV appreciation from $100 to $1116, even though she only subscribed at $110/share. This is known as "Clawback".
If no equalisations are made, investor B will pay Performance Fee for the fund's NAV appreciation from $100 to $116, even though she subscribed at $90/share. This is known as "Free Ride", as she would get a free ride from $90 to $100.
An Equalisation Credit (EC) is created in a Subscription when the current GAV per share > HWM, which is the Peak NAV per share. If the GAV at the end of a PF period is higher than what it was at subscription, the EC is used to buy new shares for the investor. An EC would be applied to Investor A in our example above.
EC per share = (GAV - HWM) * (PF rate)
An Equalisation Deficit (ED) is created in a Subscription when the GAV per share < HWM, ie Peak NAV per share. At the end of the performance period, the ED is used to sell shares for the investor. An ED would be applied to Investor B in our example above.
ED per share = (HWM - GAV) * (PF rate)