Crystallization

A performance fee is accrued at every NAV but remains contingent: if performance falls, the accrual is reduced. Crystallization is the event that locks in the accrued amount. The offering documents define the crystallization frequency, commonly annual or quarterly, and it also usually occurs pro rata when an investor redeems.

Once crystallized, the fee becomes a payable to the manager and the high-water mark is reset to the post-fee NAV. More frequent crystallization tends to favor the manager, because gains are locked in before later losses can offset them.

Pitfalls include failing to crystallize on redemptions, crystallizing on the wrong date or NAV, and not resetting the HWM for the redeemed or remaining shares correctly. Where investors redeem mid-period, the crystallized amount on the redeemed shares should be calculated separately from the accrual that remains on continuing shares, and both should be visible in the NAV pack.

Example

A class starts the year at $100 (HWM $100) with a 20% fee and annual crystallization. At Q1, NAV before fees is $110, so the accrual is $2.00. At Q2 it falls to $104 and the accrual reduces to $0.80. At year-end it is $108, so $1.60 per share crystallizes and becomes payable. The new HWM is $106.40.