What Causes the J-Curve?
Two things fundamentally cause the J-Curve. The principal driver is that management fees in a fund are charged based on a fund’s entire committed capital and the capital called in the early years is only a portion of the fund’s committed capital. Thus, in the early years, management fees and organizational expenses represent an unusually large portion of contributed capital. For example, in a $100 million fund with a 2% management fee, annual management fees would be $2 million per year. If the fund also has $300,000 of organizational expenses, the legal and travel expenses associated with forming the fund, then the fund would have $2.3 million of expenses in its first year. If the fund made five investments of $3 million each, was valuing them at cost and had called 20% of committed capital after its first year, then the fund’s interim value would look as follows: The fund would be considered below par on an interim valuation basis because of the $20 million of investments. The fund’s
