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Explain the mechanisms that tie a private manager's incentives to its investors' interests, and work out and assess the net returns limited partners keep after management fees and carried interest

CFA® Level III · Private Markets Pathway · General Partner and Investor Perspectives and the Investment Process · L3.PK.2.b

The idea

Interests are aligned through the GP's own commitment, a carried interest paid only on profits, a hurdle or preferred return, a catch-up, clawback provisions, fee offsets and key-person clauses. Management fees are usually charged on committed capital during the investment period and on invested capital or NAV afterwards. In a whole-fund (European) waterfall, LPs receive their paid-in capital and hurdle before any carry. Suppose 100 is paid in and 160 is returned. The profit is 60 and 20% carry is 12, so LPs receive 148. The gross multiple is 1.60 but the net multiple is 1.48. The trap: a deal-by-deal (American) waterfall pays carry early, and if later deals lose money the GP is overpaid unless clawback is enforceable.

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