Question 1

What is carried interest?

Accepted Answer

Carried interest is a share of a private investment fund’s profits allocated to its manager as compensation for managing investments, rather than a return on the manager’s own capital. It aligns compensation with performance and is separate from management fees.

Question 2

What is the 2 and 20 fee structure?

Accepted Answer

Two and twenty is the classic fee model for private equity and hedge funds: a 2% annual management fee on assets or committed capital, plus 20% of profits as carried interest. The management fee covers the manager's operating costs, while the carry rewards performance. Many funds now charge less, and terms vary widely, so investors should read the fee section of the offering documents closely.

Question 3

What is the carried interest loophole?

Accepted Answer

Carried interest is usually taxed as a long-term capital gain rather than as ordinary income, even though it is compensation for managing money. Critics call this the carried interest loophole because capital gains rates are lower than top income tax rates. Since 2018, managers must generally hold the underlying investments for more than three years to receive capital gains treatment on carry.

Question 4

What is a hurdle rate or preferred return?

Accepted Answer

A hurdle rate, often called a preferred return, is the minimum return investors must receive before the manager earns carried interest. Eight percent a year is a common figure in private equity. Once investors clear the hurdle, many funds let the manager catch up on its share of profits. The hurdle helps ensure the manager is paid for real performance rather than modest gains.

What is carried interest?