Carried Interest / Performance Fee / Incentive Fee
Carried interest, or carry, is a share of any profits that the general partners of private equity and hedge funds receive as compensation. This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund’s performance. Carried interest serves as one of the sources of income for a fund manager, traditionally amounting to 20% of the fund’s overall profit. This normally kicks in above a certain rate of return, typically an 8% annualized return. For example (for a fund with 20% carry above an 8% hurdle), first a fund must generate an 8% annual return on capital called. Second, the fund manager will receive 100% of all additional distributions until they “catch up” to an overall 20% of all distributions. Thereafter, any distributions in excess of the first two steps are split 80% to the investors/LPs and 20% to the fund manager.