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Archive for June, 2010

Saw SINOTOP and SINOTOP-OR (the rights share) trading as most active stocks today and wonder what they are. Did a search and realized it is the previous John Master (now a empty shell company). Be Top, a textile company in China is taking up the shell company to get listed in Bursa [geek call this ‘reversed merger’]. Then they try to raise $$$ by issuing 10 rights shares for every 1 share. Exactly like stock options, holder of the rights shares can buy 1 new share at ‘only’ RM0.20.

What is so confusing and interesting is this -

SINOTOP is actually selling for RM0.65 while the right is sold at RM0.12. It means, if you want to own SINOTOP shares, you can either buy directly at the market now at RM0.65, or you can buy the right share (SINOTOP-OR) at RM0.12 and exercise it to get new shares at RM0.20 with a total cost of only RM0.32!!! A discrepancy of RM0.65 to RM0.32, 100% differences!!!

What went wrong? I don’t know yet. But at least what we know is, if you are a holder of SINOTOP shares, the only sane thing to do is to sell every SINOTOP you have and bought an equivalent amount of SINOTOP-OR and fully exercise them. By doing that you will reduce your cost by 50% immediately!

Again, I know nothing about this business. And I don’t like textile company either (Berkshire Hathaway used to be a textile company that failed, a Warren Buffett investment ‘mistake’).

Calculating the pricing or market share price and the right price is not simple mathematics (at least to me). It reminds me of the time where I needed to calculate the amount of electrons in a silicon and the dy/dx… I hate those and doing this right issue calculation now make my head spin again like old time. But still, let me try my best on it and we learn together.


Every time there is a right issue, you need to make 2 formulas (actually 3). The 2 formulas allows you to link the market price BEFORE the right issue with the market price AFTER the right issue. Because after a right issue, the market price will immediately drop. You can only compare the BEFORE and AFTER price if you can either convert the AFTER price to BEFORE equivalent or convert the BEFORE price to AFTER equivalent.

It is like changing from kilograms to pound or kilometers to miles … you can only compare the market price either using the AFTER metrics or BEFORE metrics. Say today the AFTER rights price is RM0.65, what is the equivalent price BEFORE the rights issue? And 1 month ago, the BEFORE rights price is RM0.85, what is the equivalent AFTER rights price today?

The 3rd formula is actually the SINOTOP-OR (the right share) price. This is the most straightforward formula. We will later use this formula to get the other 2 formulas.

Rights Price = Market Price after rights issue – Rights Issue Price

(note: rights price is the rights market price, rights issue price is the strike price, the exercise price)


The right shares, like call options and stock options, allow you to buy the underlying share at a fixed amount, that’s RM0.20 (geeks call this ‘strike price’). So technically, the right price will simply be the market price minus the strike price. Because you either buy directly at market price, or you buy the rights shares first (like paying upfront deposit) and pay the remaining later when you exercise it. No matter which way you do, you are getting the same thing in the end, the SINOTOP shares, the same apples.

If SINOTOP-OR is trading below SINOTOP AFTER – 0.20, we say it is trading at a discount, because by buying this ‘apple’ via the rights issue, you get the apple cheaper by buying it directly in the market.

On the other hand, if SINOTOP is trading above SINOTOP AFTER – 0.20, we say it is trading at a premium, because this apple is now more expensive than the market price.

“Usually”, we seldom see behavior like SINOTOP where there is a significant difference between the rights price and the market price (a big discount in this case). Usually they are almost the same, either slight discount or slight premium.

Uninformed investor who sell SINOTOP-OR is understandable because rights shares have short life, usually a week (geek call it the ‘expiry date’). After this date, your rights is worthless and you can no longer sell it in the market, the only thing you can do is exercise it at the strike price and get new shares. So the only reason you want to hold rights shares is to exercise it. To exercise it, you need to take fresh money out from your wallet. So if an existing shareholders who doesn’t plan to exercise the rights or have no money to exercise the rights, he will have to sell the rights shares before it expires to get some money. Or else, he will get nothing after they expire!

And since SINOTOP is issuing a massive 10 rights share for 1 existing shares, existing investors suddenly have 10 rights share, they either have to come up with the 10 rights share money or they will have no choice but to dump it at the open market. And they can only sell within a week! Lots of supply in a short period of time, but no demand.

That’s why next time if you encounter such scenario where one of your stock holdings is issuing massive rights and you still want to own this stock, sell some of it before you get the rights to raise your cash and then buy back back again through the rights. Do not plan to sell the rights because many people are trying to do the same and you won’t get good price for your rights!

[Many companies issue rights but usually they don’t issue 10 right for 1. They normally issue say 1 right for 4, or 1 right for 8 so that is acceptable and it won’t create too much sell supply to the rights shares, like BSTEAD and AXIATA previously]

What went wrong with SINOTOP is still unknown, and why got sohai buying up at the market is also unknown! Because I have shown you, it didn’t make sense to buy at market price and sell the rights! Instead you should do the other way, sell at market price and buy the rights!

If you do not have the 2 formulas in hand, you can’t compare the differences BEFORE and AFTER and so you won’t be able to know how much the market price of SINOTOP has shot up since the rights issue. Let’s derived the 2 formulas.

Market Price before rights issue = Market Price after rights issue + ( Ratio x  Rights Price )

The Ratio is 10:1 so is 10. The Rights Price has been derived earlier. Replacing the ratio and rights price, we get



SINOTOP BEFORE = 11 SINOTOP AFTER – RM2.00 … formula (1) to convert the AFTER price to BEFORE price equivalent for comparison.

By reversing the formula, we get

SINOTOP AFTER = ( SINOTOP BEFORE + RM2.00 ) / 11 … formula (2) to convert the BEFORE price to AFTER price equivalent for comparison.

Actually they are the same formula, depending on whether you want to convert km to miles or convert miles to km.

Since the right will expire very soon (in a week) and cease to exist, so this 2 formulas are more important than the rights formula earlier. The rights will be RM0 after it expires.

To make sense of SINOTOP, just the day before the right issue, it was traded around RM1.60. Just a day after the right issue, it was around RM0.40. To link this 2 numbers together, you can either convert the BEFORE price to AFTER or the AFTER price to before. You can use either formula.

If it is RM0.40 AFTER, what it is the equivalent BEFORE?


  = 11 x RM0.40 – RM2

  = RM2.40

That means SINOTOP has ‘technically’ shot up from RM1.60 to $2.40 in terms of BEFORE price, a 50% raise in high volume in 1 day!

4 days later, the AFTER price shoot up to RM0.65. Converting it to BEFORE price, it would be RM5.15!!! 220% gain from RM1.60 in 4 days after the rights issue. No wonder BURSA is issuing them questioning letter. But the directors responded in the same way, “we are not aware of anything.”

This is more mysterious when you take into consideration that just 1 month earlier, the BEFORE price is only RM0.85. An increase from RM0.85 to RM5.15 in 1 month is 500%!

And even MORE mysterious is that there are rights shares pending that sell for only RM0.12 with an issue price of RM0.20! Again who is the sohai who buy SINOTOP at the market but refuse to buy the SINOTOP-OR and exercise it to get SINOTOP shares for 50% discount to market price?

It is possible that I did the wrong calculation above, if you spot any mistakes, please let me know as I am eager to find out too.

To make more sense, let’s get back to basic formula that normal investor can understand easier.

A BEFORE investor who buy at BEFORE price will now be holding the same stock at AFTER price + 10 rights shares. This is our basic formula.

Market Price before rights issue = Market Price after rights issue + ( Ratio x  Rights Price )


The investor might be thinking that since BEFORE the rights, it is at RM1.60, and AFTER the right, it is RM0.65, so they estimate that the “right” rights price should be


That way they get the rights price at (RM1.60 – RM0.65)/10 = RM0.095. If they are able to sell their rights shares above RM0.095, they are still much richer than before by holding the “inflated” RM0.65 SINOTOP shares.

But I don’t think they should be too happy because the pricing of SINOTOP after right issue is far way off from logic. As I have shown you, RM0.65 means an equivalent of RM5.15 for the BEFORE price! A jump of 220% in 4 days! Unless you have unloaded everything (both the shares and the rights), you are “richer” because you are relying on the inflated SINOTOP share price.

Problem #1 – SINOTOP price is highly inflated. It jumped 220% in 4 days.

Problem #2 – 50% mispricing between SINOTOP and SINOTOP-OR. Buying SINOTOP-OR to get SINOTOP is 50% cheaper than buying SINOTOP at market. But they are the same apple!

Let’s turn the mirror and use formula (2) to compare in AFTER price.

SINOTOP AFTER= [ SINOTOP BEFORE + RM2.00 ] / 11 … formula (2)

Before the rights issue, SINOTOP is trading at around RM1.60. So technically, SINOTOP AFTER should be worth RM0.33 after the right issue if it is equivalent to RM1.60. But it is RM0.65 now! Almost 100% jump in 4 days.

The pricing of the right is about “right” right now [sorry for using 3 right words in 1 sentence].

Because if you get the right at RM0.12, and exercise to get the stock at RM0.20, your total cost would be RM0.32, almost equivalent to the RM1.60 price before the right issue. So now we know getting the shares through the rights “right” now is almost the same as buying it at RM1.60 before the right issue.

And since one month ago it is traded at only around RM0.85, the equivalent AFTER price would be only (RM0.85 + RM2.00) / 11 = RM0.25!!!

I also think formula (2) is a better metric to use than formula (1) because it can explain in this way – If you have bought the SINOTOP shares before the right issue and you exercise all your rights, what is your average cost for your SINOTOP shares? If you bought it at RM1.60, and exercise all shares at RM2.00, you got 11 shares in return. So averaged cost is RM0.33, which is formula (2). Selling it later at RM0.65 gives you a profit of almost 100% based on your cost.

Formula (2) is also the formula to adjust historical pricing in stocks charts before the rights issue.

So if you are a SINOTOP shareholders or plan to buy SINOTOP, it is your homework to know if SINOTOP is really worth RM1.60 BEFORE the rights issue (which is equivalent to your cost of RM0.32 right now if you buy through rights). If it is not worth RM0.32 right now, it is definitely not worth RM0.65.

The market price now is inflated to RM0.65, if you are buying the rights to get the shares, do you think the stock price will still be RM0.65 after you get the shares (around 1 month)? If yes, you will make a 100% profit! You will be profitable as long as it is above RM0.32. But really got naked woman walking on the street? Some nude beach got but is this the rare nude beach?

I got itchy and bought a little bit of SINOTOP-OR before I do any homework (bad role model). I do so to motivate me to work out the numbers (lame excuse) and now I have to admit that I wish I have not bought any. I either have to sell it at a loss tomorrow or work out the real fundamentals numbers of Be Tops before I decide if I want to go ahead and exercise the rights.

Ahhh, pain in the ass. If you know anything about SINOTOP or saw any mistakes I made in the calculation, please write a comment below. Thank you.

p/s Why using formula (1) gives us 220% gain while formula (2) is only 100%? This is because when we compare in BEFORE price, the new rights shares haven’t exist and we need to deduct the cost out from it ($2). So the % gain is based only on initial cost buying the pre-right shares only (without including the new cost to buy the new shares). On the other hand, formula (2) which is more realistic, averaging the gain with all shares and cost. I have to admit, I am confused myself. :)

If an investor bought RM10,000 of shares before the rights issue at RM1.60, he got 6,250 shares. After the right issue, he will get 62,500 right shares and if he exercised them all at RM0.20, he will need another RM12,500, making his total investment RM22,500 and he will now have a total shares of 68,750. If the stock is selling at RM0.65 today, his whole investment will be worth 68,750 x RM0.65 = RM44,687, which is almost 100% gain. Which is formula (2).

On the other hand, if we use the “unrealistic” formula (1), we need to get back to the time where there is no rights issue. So although the whole investment is worth RM44,687, we need to deduct the investment cost of RM12,500 to it, and get RM32,187. That will be a gain of 220% comparing to the cost of RM10,000. We have assume 0% gain from the shares obtained from the rights shares and attribute all profits to the pre-rights shares. Not an accurate representation.

This blog doesn’t make a single cent and will not make any in the future. Then what is the purpose of setting up this blog? To practice my English writing skill for my triple-one-nine English test? No! It is a blog to show you other ways to look at things. Everything can be seen from at least 2 sides. Everything will have at least 2 stories told by 2 parties involved.

Car A hit Car B, driver A will have different story than driver B. I am here to give you more perspectives. These are not “right” or “wrong” perspectives. They are just “another” perspectives, because I believe if you can see things more ways, you can make better judgments and decisions. And at the end, the more you see, the more you know “you don’t know” and you will be more humble.

Tan Teng Boo responded to the i Capital International Value Fund and i Capital Global Fund performance fee issue that I brought out earlier in his newsletter on 11/06/2010 under “KLSE Conclusion and Recommendation”. Here are the quotes and my respond. All bold are bolded by me for highlight purpose.

To earn the performance fee, Capital Dynamics must surpass the highest and the most difficult hurdle rates and high water mark anywhere in the world. Our unique fee structure is rather complicated (as a result, some investors are confused by it) but it is easily the fairest to clients and the toughest to meet. As our managing director has explained before, if Warren Buffett knew about our performance fee structure, he would immediately pass his funds to us to manage.

So it is now OK for value investor to invest in investments that is complicated and that we don’t understand? Remember the subprime mortgage investments that brought the last financial crisis? They are complicated enough.

If it is complicated, either explain it until we are not confuse, or make it simpler. “Just trust me and I will do the ‘best’ for you” is not an investing method. And the last sentence that quote Warren Buffet (and all other uncountable incidents) is what I mean by his “character” and “ego” that you need to watch carefully. If Ah Beng charges Warren Buffett only 0.0002% performance fee, Warren Buffett will be very happy and send him 30 billion to manage.

As a fund manager, Capital Dynamics must deliver net returns of 6% on (1) a single year and (2) on a compound bases. While many fund managers do not bother to even have a single hurdle rate and still charge performance fee, for Capital Dynamics and i Capital, there are ACTUALLY two hurdle rates to surpass in any single year. And of the 2 hurdle rates, one is actually on a COMPOUNDED basis (any investor who knows how tough it is to compound 6% per annum PERPETUALLY would know how tough this hurdle is).

No one challenge on this. This is true, correct and absolutely right. We are not trying to bring out this issue. We are trying to bring out an issue that most investors would have missed, a loop hole, a flaw, where if the fund NAV goes up and down a lot, the fund manager will be able to charge performance fee on “non performance”. If you invest at $1,000 the first year and it drops to $600 the second year, then rise back up to $1,400 the third year, the fund manager will charge you performance fee based on the profit from $600, not your initial investment of $1,000!

Again the metaphor is, if there is a mechanic and you send your car to repair, he can poke all your 4 tires and charge you for repairing it. And he can do it again and again. Poke it, fix it, charge you, poke it, fix it, charge you … as long as he is able to meet the 2 hurdles mentioned above. A long posts has been written on it and will not be repeated here. Read Tan Teng Boo’s i Capital International Value Fund and Global Fund and ALL comments in that post.

In this Star article, Up Close and Personal with Tan Teng Boo, he is quoted saying, “I’m pretty damn good at what I do. I would say I am one of the top five fund managers in the world. It is a pity that people don’t really recognize that.” If the top 5 fund managers in the world can only compound at 6%, everyone should just put their money in the fixed deposit, or better yet, AXREIT. And I doubt Warren Buffett want to pay 20% performance fee on 6% compounded return.

Again, some supposedly smart investors do not even know that our 6% compound hurdle rate is a high water mark and that it is the toughest high water mark anywhere in the world. Why ? For the simple reason that this high water mark is rising at 6% (net of all expenses) perpetually, even on Sundays and public holidays !! Can you get rich with 6% compounding ? You bet. Even Warren Buffett imposes a 6% hurdle rate. Any investor who scoffs at 6% compounding is either a dangerous gambler or a conman.

Warren Buffet imposed a 6% hurdle rate with his early partnership. He also imposed a high water mark where performance fee will not be charged again on the portion where it has been charged before. On the other hand, Capital Dynamics can double or even triple charge performance fee depending on how volatile the NAV is. So it is not apple to apple comparison.

Scoff = Laugh at, Tease at (I have to Google this word! I am certainly not a “smart” investor.) Again, top 5 fund manager in the world, 6% compounded return? Gurufocus.com has tons of gurus that can do that and certainly all of them cannot be in the top 5 of the world. Even an unmanaged index fund can easily do that. Who is “scoffing”? Who is the gambler? Who is the conman?

A high water mark is supposed to protect investor capital, means locking it, out of touch for performance fee, and yet, this look-real-look-fake illusive “high water mark” is doing 50% of the job. Once it qualify for performance fee, it won’t be used to calculate the profit, instead, last year NAV will be used. If last year NAV sucks a lot, large portion of the fund will be subject to performance fee. Again, read the old post, and look at how 2009 performance fee is calculated. The exact issue is that the “high” water mark is not doing a complete job. It is not protecting the initial capital and the portion that has been charged a fee before. REPEAT! The main issue we are talking all the time is – It is not protecting the initial capital and the portion that has been charged a fee before.

The 2 hurdle rates of 6% on a single year and compound bases are so tough to meet that if our fund’s net asset value mirrored the Dow Jones Industrial Average from 1926 to 2009, Capital Dynamics would have earned a performance fee in only 2 years of out of a total 84 years. In 1926, the Dow Jones Industrial Average was trading at 157.20 points and by 2009, it was trading at 10,067.33 points. The typical fund managers, assuming they have a simple 6% annual hurdle rate to surpass, would have earned a performance fee in 24 years out of the 84 years.

If we need to invest in Dow Jones Industrial Average, we can buy the ETF or similar mutual funds that charge very negligible fees. But I don’t think the “Top 5 Fund Manager” in the world should compare himself to an unmanaged index, especially where investor need to pay performance fee for him to perform. And again, the issue is double charging (or triple charging) of performance fee, investors are very happy to pay performance fee if the fund is really performing. But we are not happy when someone dig a hole himself, climb back up and brag about it.

Also, showing this statistics is a double sided sword. I would like to ask the fund manager this question – For “typical fund managers” who earned 24 years performance fee out of 84 years, how many of them actually beat the market, i.e. the Dow Jones Industrial Average?!!! You will be shock that almost all funds can’t beat the market and so paying them 24 years performance fee is “overvalued”.

The performance fee structure of Capital Dynamics and i Capital is based on achieving long-term investment objectives. As our managing director explained in the recent i Capital Global Fund 2010 Gathering, we would be able to earn a massively huge amount of performance fees if we instead listened to the suggestion of some investors and change our performance fee structure accordingly.

Surprise! Surprise! This paragraph and the next few paragraphs are missing in the online version, it is only in the printed version. Did they regret writing it and remove it later? Because this is the juice of the post!

The new “suggested” performance fee structure is not explained here, so we don’t know what is it, set a real high water mark but change the performance fee from 20% to 50%? We don’t know. But what I don’t understand is, which investor in the world will suggest his fund manager a new performance fee structure so the fund manager can earn massively huge amount of performance fee from him?!! What logical sense is that?

In fact, in the dinner Gathering, he actually offered to amend the current performance fee structure based on the suggestion of some investors. Of course, his suggestion was flatly rejected.

This is the kicker. If “some investors” make a suggestion, how could it be able that the suggestion is “flatly” rejected? Then who suggest at the first place? And what is their suggestions? Who on earth will reject a proposal to increase their investment return, i.e. reducing the performance fee or setting a “real” high water mark? Or is it because only 2 people attended the Gathering? More clarification required.

Any investor whose investment horizon is only 6 or 12 or even 24 months would never understand our very unique and demanding performance fee structure and how fair it is to clients.

The fund is 35 months now, not 6 or 12 or even 24. The truth on what has happened is everything we need here. After a “short term” of 35 months, the Global Fund NAV is $1,019.62. A return of 1.962% for early investor. On the other hand, the fund manager has charged more than 15% fee to the early investor. A profit sharing of 12% (investor) to 88% (fund manager) while the investor bear all the risk since they are the one putting out the capital.

The way our performance fee is structured goes far beyond what is normally understood as putting investors interests as the number one priority. Clients pay $1.00 and get many dollars back in return.

Client pay $1.00 and get 1.9 cent back, not many dollars, not even many cents (in 35 months!). Fund manager get at least 15 cents. This is not a subprime investment, or options or futures. This is supposedly a “can sleep soundly” investment as the fund manager “promised”. And to sleep soundly, investor need to know exactly how performance fee is charged. Chinese saying, “Protect your house day time, protect your house night time, at the end you still can’t protect your house if one of your family member is the ‘thieve’”. [日防夜防,家贼难防] If it cannot be “normally understood” this is not a “can sleep soundly” investment.

As we wrote at the beginning of this article, under our fund management services, we only accept clients that understand and share our Intelligently Eclectic Value Investing philosophy and to Capital Dynamics and i Capital, integrity is of vital importance.

Integrity … lol. “Talk” integrity and “Do” integrity are 2 different thing. At the end, it is what you do that counts, disregard to how well is your speech. To demonstrate the real integrity, let’s see what Mohnish Pabrai is telling his investors.

All three funds are below their historic NAVs and hence no fees were earned by any of the funds for the quarter. My immediate family has a stake of 455,562 units of PIF2; 8417 units of PIF3; 1,224,824 units of PIF4 and about 25,000 units of PIF4 in a retirement account. This stake is worth about $42 Million.

Besides the  previously disclosed  stake  and small investment in Dardashti Capital  (worth about $1.3 Million), my family has no interests in any other mutual funds, hedge funds or private equity funds.  I have a deep vested interest in the future performance of Pabrai Funds.

Pabrai Funds charges no management fee, just performance fees  – which are ¼ of the returns over 6% annualized (subject to high-water marks). I only get paid when you make money. When you win, I win. Our interests are completely aligned. I am very bullish on the long-term future of Pabrai Funds – as demonstrated by my being the single largest investor in the funds. Investors who add funds when we are below the high-water mark (like now), get a free ride (no fees) until we’re back at the high water mark plus 6% annualized from that date. It is a great deal.

i Capital Global Fund and i Capital Value fund charge 1.5% management fee no matter they make money for you or not. Pabrai charges no management fee.  Pabrai charges 25% performance fee instead of 20% but it is subjected to high water marks which means unless it beats previous high, he can’t charge any fee. Maybe in the next iCapital newsletter, Mr Tan will compare himself to Mr Pabrai. :)

International Value Fund 2009 NAV is $1.0112. If it shoot up to $1.50 this year (2010), he will charge fat performance fee ($0.079). Then if it drops back to $1.00 next year (2011). No performance fee. And the 3rd year, if it ends up at $1.30 (2012), significantly below previous high of $1.50, he can still charge you fat performance fee because it is above 6% from $1 (first hurdle) and 6% compounded for 3.5 years which is $1.226 (second hurdle).

How much is the performance fee? 20% of ($1.30 – $1.06) = $0.048! $1.06 (6% above 2011 NAV) is used when calculating how much is charged, not $1.226! The NAV after fee will become $1.252. Remember the ending NAV is all you have got no matter how high it has hit before. Although the fund has hit $1.50 before, it is only “paper” and “historical”. You got your 25 cents profit while the fund manager has charged twice fat performance fee in year 2010 (7.9 cents) and 2011 (4.8 cents). This is how his performance fee is structured.

The more long term you are, the more chance you will encounter it. No underperformance fee is charged when the fund drop from $1.50 to $1.00. No allowance for you to buy sleeping pills on your sleepless night too when you see your “paper profit” evaporate when the fund drop from $1.50 to $1.00 [While the fund manager has pocketed 7.9 cents earlier and sleep soundly].

The missing paragraphs in the online edition ends here. The following appear both online and paper. Probably they will add back the missing part after they read my post. :)

Given the turbulent economic and market conditions, how should subscribers position themselves ? Being a value investor helps. Value investing allows one to turn turbulence and volatility into opportunities. For investors, the i Capital International Value Fund is an obvious choice. The Australian Dollar has dropped against the Ringgit. Its NAV has fallen. Essentially, one gets a double discount.

Being a value investor indeed can turn turbulence and volatility into opportunities, but only with the correct performance fee! If a performance fee can be charged again and again by running around the field (you run 10 loops you are still standing on the same spot), then it is the fund manager that turns the turbulence and volatility into their opportunities. The fund manager wins, you lose.

And why the fund manager choose to promote his International Value Fund instead of ICAP which is more of a bargain? Because ICAP is a closed-end-fund so doesn’t need new customers/investors?  Because ICAP doesn’t charge any performance fee and so they are not interested in promoting “low margin” product?

If you are an investor, Tan Teng Boo is showing half of the picture to you, I am trying to show you the other half. I am not here to debate right or wrong, I just want you to see the whole picture. I didn’t charge you blogging fee and performance fee! :)

p/s I want to thank bullbear for writing the article on i Capital Global Fund and Value Fund Performance Fee.

Some other good reading (surprise!)


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