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FRM Part II · FRM Exam Part II · Private Markets Investing

A pension fund is reviewing a private equity limited partnership agreement. Which provision is most directly designed to align the general partner's incentives with those of the limited partners by ensuring the LPs receive their capital contributions and a preferred return before the GP earns carried interest on the whole fund?

A European whole-fund waterfall with a hurdle rate best aligns incentives, because limited partners receive all contributed capital plus the preferred return before the general partner earns carried interest. Deal-by-deal waterfalls without clawback allow early carry on winners and are less protective of investors.

  1. AA management fee calculated on committed capital
  2. BA European (whole-fund) distribution waterfall with a hurdle rateCorrect
  3. CA deal-by-deal (American) waterfall with no clawback
  4. DA key-person clause

Explanation

A whole-fund waterfall returns all contributed capital and the preferred return to LPs before the GP receives carry, which aligns incentives. A deal-by-deal waterfall without clawback lets the GP take carry early on winners. Management fees on committed capital and key-person clauses do not govern carry timing.

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