The crystallization frequency or incentive fee payment frequency of a hedge fund’s fee structure specifies the frequency with which the hedge fund updates the high-water mark. While the performance fee crystallization frequency might appear a trivial element in determining the level of hedge fund fees, it has a significant impact on the amount of fees investors can be expected to pay. As such, hedge funds with the same headline fee levels (e.g. a 2/20 hedge fund fee structure) can differ considerably in their fee load.
In what follows, we define the crystallization frequency and refer to some recent academic research that analyzes the impact of the crystallization frequency on the ‘total expense ratio‘ of hedge funds.
Crystallization frequency definition
The crystallization frequency
specifies the frequency with which the hedge fund manager updates the high-water mark.
Alternatively, we could also say that the crystallization frequency is
the point in time when the hedge fund manager determines the amount of performance fee that is due and charges it to the hedge fund investor’s account.
Common crystallization frequencies
What crystallization frequency do hedge funds commonly use? Academics commonly assume that hedge funds charge the performance fee at the end of the calendar year and thus update the high-water mark only once a year. However, annual crystallization is not necessarily used by all hedge funds. Recent research suggests that some hedge fund categories use other crystallization frequencies. In particular, recent research by Elaut, Frömmel, and Sjödin suggests that CTAs mostly use quarterly crystallization.
On this page, we have discussed the concept of performance fee crystallization. It refers to the frequency with which hedge fund update the high-water mark and charge the performance fee. While this payment frequency is often assumed to be annual, some hedge fund categories (e.g. Managed Futures) tend to use higher payment frequencies such as quarterly payment. The higher the crystallization frequency, the higher the total fees paid by the hedge fund investor.