Talvir Capital charges a 20% performance fee over an 8% hurdle. At a gross return of 12% on Rs 1,000 crore, what fee does it earn under a hard hurdle and under a soft hurdle with full catch-up?

A hard hurdle pays Talvir Rs 8 crore and a soft hurdle with full catch-up pays Rs 24 crore, three times as much. The hard hurdle charges 20% only on the Rs 40 crore above 8%. The catch-up gives the manager everything above 8% until it holds 20% of all profit, which it reaches at a 10% gross return. The investor nets 11.2% under one wording and 9.6% under the other.

Think of a salesperson paid a 20% commission on sales above a monthly target. Under one contract the commission is paid only on the sales above target; under the other, once the target is cleared, the commission is backdated to the first rupee. A hard hurdle charges the fee only on returns above the hurdle; a soft hurdle with full catch-upA clause that gives the manager all, or most, of the returns just above the hurdle until its share of total profit reaches the full performance fee rate. charges it on all the return once the hurdle is passed. The hurdle protects the investor's first 8% either way; the wording decides what happens after.

Hard hurdle: the investor keeps the first Rs 80 crore, and the manager takes 20% of the Rs 40 crore above it, Rs 8 crore. The investor nets Rs 112 crore, 11.2%. Soft hurdle with full catch-up: the investor keeps the first Rs 80 crore, the manager then takes 100% of the next Rs 20 crore, and the last Rs 20 crore is split 80 to 20, so the manager ends with Rs 24 crore, exactly 20% of all the profit. The investor nets Rs 96 crore, 9.6%. The catch-up is complete once the manager's Rs 20 crore equals 20% of the Rs 100 crore earned so far, which happens at a 10% gross return.

Below 8% neither wording pays a fee. Between 8% and 10% the catch-up hands the manager every rupee of return, so the investor's net return is stuck at 8%; above 10% the soft hurdle with catch-up charges the same as having no hurdle at all. The hard hurdle's advantage to the investor stays at Rs 16 crore at every return above 10%, 1.6% of the fund a year. That is why allocators read hurdle definitions line by line, and why the word soft on its own does not tell you enough: a soft hurdle without catch-up can mean something different again.

Two further lines complete the review. The management fee comes on top, so net returns are lower than these figures. And a high-water mark decides whether a fee is charged at all after a losing year. An allocator should model the fee on the fund's realistic range of returns, not at one point, because the catch-up's cost is concentrated just above the hurdle, where a modest year lands.