How does carried interest work in practice at a HF? Do your LPs write you a check for the amount of returns that you generated, even though technically it is a paper return? Or is the carried interest paid through the fund (ie. GP has to sell some shares to pay itself)?
Any difference for management fees?
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Generally speaking hedge fund fees due to the general partner (the "GP"/"manager") (both base and incentive) are payable in cash on a mark-to-market basis. This is usually done via assets already held by the limited partNERSHIP ("the fund"), as opposed to by the limited partNERS ( the "LPs"/investors).
So to answer your question, yes you owe the cash fees on a "paper" gain; to answer your other question yes you theoretically pay it by selling assets of the fund. In a very simple case a fund with assets consisting entirely of 120 shares of stock trading at $1 that owed $10 of base and incentive management fees would have to sell 10 shares of stock to make that payment.
In practice a fund has sources of liquidity besides just selling investments (borrowing capacity in margin accounts, cash on hand/received from dividends and coupons, potentially proceeds from new subscriptions to the fund, etc). There are also a million nuances and iterations related to the tax, position sizing etc implications of selling a given investment; managing this sort of operational/tax/liquidity stuff for funds is a big part of the back and middle-office functions at a fund manager (this goes for traditional/long-only funds too by the way, and often times even more so because of the more frequent liquidity provided to investors).
One other nuance is that in some instances the GP can take its fees "in kind" as "interests" (aka limited partnership units) in the fund if it so chooses (for example if this is more tax efficient for the GP/its stakeholders).
This is somewhat different from PE-style funds, where incentive fees are generally paid upon liquidity events (ie selling an investment), though there are a lot of different flavors of that as well and some of them still involve some sort of mark/assumption on the value of unrealized investments.
N.B.1: "carried interest" as a term seems to be more common with regards to PE funds vs. HFs in my experience. N.B.2: This is all distinct from "carried interest" as a colloquial term for performance-related compensation for employees/stakeholders of the GP, which can take a number of forms depending on the manager and employee.
Thanks!
"Carried Interest" at Hedge Funds (Originally Posted: 01/29/2008)
Hi,
Is there carried interest (or an equivalent) at hedge funds? People always talk about how PE firms pay their employees base+bonus+carried interest (beginning from VP-level), at Hedge Funds, you only hear about base+bonus.
So is there some sort of profit share (other than the bonus) in Hedge Funds as well? If so, at what level does that participation start?
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