Lesson 6 of 6 · All lessons in this module
- What makes an investment alternative
- Private capital and hedge funds
- Real assets: real estate, infrastructure, natural resources and more
- Three ways in: fund investing, co-investing and direct investingVideo lesson
- Ownership structures: limited partnerships and beyond
- Compensation: fees, hurdles, catch-ups, clawbacks and waterfallsVideo lesson
Lesson 6 of 6 · 15 min
Compensation: fees, hurdles, catch-ups, clawbacks and waterfalls
Alternative managers earn a management fee plus a performance fee on returns above a hurdle, and a set of adjustments (catch-up clauses, high-water marks, clawbacks and the choice of waterfall) decides how much of the profit the GP really gets and when.
In short
- Management fee: often 1%–2%; on assets under management for hedge funds and REITs, on committed capital for private equity funds.
- Basing PE fees on committed capital removes the incentive to deploy capital quickly just to raise fees, so the GP can be selective.
- Performance fee (incentive fee, carried interest, carry): a share of profits, usually earned only above a hurdle rate (preferred return). The management fee is paid even if the hurdle is missed.
- Hard hurdle: fee only on the return above the hurdle. Soft hurdle: once the hurdle is beaten, the fee applies to the whole return, via a catch-up clause.
- High-water mark: no performance fee until the fund exceeds its previous peak value (net of fees). Clawback: LPs can reclaim performance fees already paid.
- Deal-by-deal (American) waterfall favours the GP; whole-of-fund (European) waterfall favours the LPs.
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