About
Foundational Principles In the Community Diversity, Equity & Inclusion Technical Excellence Alumni TIAG Membership
Careers
Why Cohen & Co Our Culture Total Rewards & Benefits Early Career Opportunities Experienced Opportunities Join Our Talent Community
Contact
Akron, OH Baltimore, MD Buffalo, NY Chicago, IL Cleveland, OH Deer Park, IL Denver, CO Detroit, MI Milwaukee, WI New York, NY Philadelphia, PA Pittsburgh, PA St. Clair Shores, MI Youngstown, OH
Client Portal
Services Industries Knowledge Center People

About Our Services

We offer tailored solutions — whether private company or owner; public or private fund, adviser or fund service provider; or Fortune 1000 enterprise. Learn how we can help you.

Find Services

Assurance Services

Employee Benefit Plan Audits Internal Controls Investment Company Audits Private Company Audits

Tax Services

Federal Tax Planning & Compliance High Net Worth & Wealth Transfer International Filings & Structuring Investment Company Tax State & Local Tax Tax Credits & Incentives Transaction Tax Planning

Advisory Services

Business Valuations Data & Insights Digital Finance Solutions IT Strategy & Implementation Litigation Support Services M&A Advisory Outsourced Accounting Solutions Transaction Services Turnaround & Restructuring

Our Industry Expertise

Our industry experience means you can find professionals who speak your language and bring earned insights to the table. Learn how we can help you.

Explore Industries

Key Industries

Digital Assets Investment Companies Manufacturing Private Companies Private Equity Real Estate & Construction Technology & Life Science
VIEW THE COMPLETE LIST

Knowledge Center

Our team wants to help your team stay up to date. Browse our thought leadership, events and news for insights and a point of view on business-critical topics.

Find Insights & Events

Insights

Browse valuable articles and publications our experts have written to help you and your organization answer key questions — and consider new ones.

Read Our Insights

Events

Join us in person and online for events that address timely topics and key business considerations.

Explore Our Events

News

Find out what is happening at Cohen & Co, from industry recognitions and growth updates, to where we are contributing to important media stories.

Read Our News
People
Foundational Principles In the Community Diversity, Equity & Inclusion Technical Excellence Alumni TIAG Membership
Why Cohen & Co Our Culture Total Rewards & Benefits Early Career Opportunities Experienced Opportunities Join Our Talent Community
Akron, OH Baltimore, MD Buffalo, NY Chicago, IL Cleveland, OH Deer Park, IL Denver, CO Detroit, MI Milwaukee, WI New York, NY Philadelphia, PA Pittsburgh, PA St. Clair Shores, MI Youngstown, OH
Client Portal
Back to Insights

Considerations for Fund Managers Calculating Incentive Fees Involving Liquid and Illiquid Investments

by Jeff Megaro

February 11, 2020 Digital Assets

It is hard to overstate the ingenuity and volatility experienced through the digital markets since the first cryptocurrency, Bitcoin, was created in 2009. That volatility, and possibly the limited investor base, has created a unique situation for investment companies holding digital assets — a mixed portfolio of both liquid and illiquid investments.

Along with this unique situation comes equally unique complexities in determining incentive and performance fee (incentive) calculations. As a fund manager, this is an important area to understand and address.

Illiquid vs. Liquid Investments and the Side Pocket

Determining whether an investment is illiquid can be simple in the case of certain Initial Coin Offerings (ICOs), Simple Agreements for Future Tokens (SAFTs), etc. However, for many freely tradable digital assets, liquidity can be frequently in flux depending on the assets held and the size of the position.

For example, some assets may be so thinly traded compared to an entity’s holdings that even transacting a fraction of its assets can move the markets significantly. Given U.S. Generally Accepted Accounting Principles’ (GAAP’s) disallowance of blockage discounts in determining fair value of investments, there may be discrepancies in what investors would receive if all investments were liquidated on a measurement date and what should be reported as fair value under GAAP.

A lot of recommendations have been made to move illiquid investments into side pockets, a strategy not typically seen in a traditional hedge fund, as historically liquid and illiquid investments would not be commingled in the same fund or portfolio. While this solution alleviates the challenge of treating investors equitably, by attributing gains/losses on illiquid investments solely to investors that put up value at risk by being in the fund when the investments were made, the use of side pockets still leaves unique complexities on incentive and performance fee (incentive) calculations.

In accordance with common practice in applying GAAP, if a nonregistered investment partnership reports capital by investor class, the accrued incentive should be reflected in the equity balances of each class of shareholder or partner at the measurement date, as if the investment company had realized all assets and settled all liabilities at the fair values reported in the financial statements. The calculation to determine accrued incentive is generally not overly complex. However, the determination of when incentive fees should be crystallized — or how they should be calculated and actually charged to an investor — is subject to greater complexity and is driven more by the fund’s governing documents and less by GAAP standards.

What Fund Managers Should Consider

As a fund manager, it’s imperative that you ensure your documents clearly define the methodology for incentive crystallization. Some key considerations to address include:

  1. Are unrealized gains within a side pocket subject to incentive crystallization at the fund’s standard crystallization date (typically year-end)?
  2. Are realized gains within a side pocket subject to incentive crystallization at the date the gains are realized, or are they moved into the investor’s liquid portfolio balance where they will be included with gains and offset against losses within the liquid portfolio at the fund’s standard crystallization date?
  3. Should a fully redeemed investor (with respect to its liquid portfolio balance) surrender the benefit of any liquid loss carryforward, or is it maintained to offset any future gains from side pocketed investments?

While there will be diversity in practice across funds, it is critical to understand the accounting complexities created by your fund’s portfolio, develop the appropriate policies and procedures to address them, and ensure you properly disclose them to investors. As the investable universe of digital assets continues to evolve, there is likely more to come on the question of performance and fee calculations in a mixed portfolio.

Contact Jeff Megaro at jmegaro@cohenco.com or a member of your service team to discuss this topic further.

Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.

About the Author

Jeff Megaro, CPA

Partner, Cohen & Co Advisory, LLC
Partner, Cohen & Company, Ltd.
jmegaro@cohenco.com
410.891.0300
Sign Up for Our Emails & Events

Receive insights from our specialists in a variety of areas and timely information on upcoming events directly to your inbox as they go live in our online Knowledge Center.

Subscribe Today
Top
Subscribe to our newsletter
About Contact Submit RFP Privacy Policy

"Cohen & Co" is the brand name under which Cohen & Company, Ltd. and Cohen & Co Advisory, LLC, and its subsidiary entities, provide professional services.

Cohen & Company, Ltd. and Cohen & Co Advisory, LLC practice in an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations and professional standards.

Cohen & Company, Ltd. is a licensed independent CPA firm that provides attest services to its clients. Cohen & Co Advisory, LLC and its subsidiary entities provide tax, advisory and business consulting services to their clients and are not licensed CPA firms.

The entities operating under the Cohen & Co brand are independently owned and are not responsible for the services provided by any other entity operating under the Cohen & Co brand. Our use of terms such as “our firm,” “we,” “us” and other terms of similar import denote the alternative practice structure of Cohen & Company, Ltd. and Cohen & Co Advisory, LLC.

© 2025 Cohen & Co