You hold a Rs 50 crore LP stake in Tamrit Capital, which charges 2 and 20 and is 15% below its high-water mark. You expect gross returns of 12% a year. What is the stake worth to you, and to a buyer, given the fee holiday until the mark is regained?

To you the stake is worth about Rs 51.6 crore, above its Rs 50 crore NAV, because Tamrit charges no performance fee for about 1.7 years while it climbs back to its high-water mark. The same stake in a fund at its mark would be worth Rs 50.0 crore. A cautious buyer wanting 10% would pay about Rs 43.7 crore, still more than the Rs 42.3 crore it would pay for a stake at the mark. The holiday is real value, but manager risk can erase it.

Because the next stretch of gains is free of the performance fee. A gym that charges a bonus fee only when you beat your best-ever weight will charge nothing while you regain the weight you lost over the holidays. Tamrit must grow 100 / 85 = 1.176x to get back to its high-water markThe highest NAV on which a performance fee has been paid. No new performance fee is charged until the NAV climbs back above it., and at about 10% a year after the management fee that takes about 1.7 years. With yearly crystallisation, the first performance fee is charged only at the end of year two, and only on the small gain above the mark. Over the first two years that saves you about Rs 1.7 crore against a stake in a fund starting at its mark.

Project the NAV, then discount at the return you want. At 12% gross, 2 and 20 with the fee holiday, Rs 50 crore grows to about Rs 75.8 crore in five years; discounted at 8%, that is worth Rs 51.6 crore today. The same stake in a fund at its mark grows only to Rs 73.5 crore, which at 8% is worth exactly its Rs 50 crore NAV. So the fee holiday adds about Rs 1.6 crore, 3.2% of NAV, to what the stake is worth to you.

The buyer changes two inputs. Assuming 10% gross, the holiday lasts longer, about 2.1 years, but the NAV grows only to Rs 70.4 crore; discounted at the buyer's 10%, that is Rs 43.7 crore, about 87% of NAV. A stake at the mark would fetch only Rs 42.3 crore on the same assumptions, so even a cautious buyer should pay about Rs 1.4 crore for the holiday. The gap between your Rs 51.6 crore and the buyer's Rs 43.7 crore is the price of liquidity and of the buyer's lower confidence in the manager.

Close with what the arithmetic leaves out. A manager earning only the management fee for two years may lose staff or close the fund and relaunch a new one with a fresh mark, which destroys the holiday. Other LPs may redeem, shrinking the fund and raising its costs. And the 12% assumption comes from a manager who has just lost 15%. A strong answer values the holiday, then asks why the fund fell and whether the team will still be there when the mark is regained.