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

An LP in a private equity fund wants to reduce the conflict between fee income and performance for the GP. Which fee term most directly addresses the concern that the GP is rewarded for raising and holding capital rather than generating returns?

Stepping the management fee down to invested capital after the investment period best aligns incentives. It reduces fees on capital that has been returned or not deployed, so the GP's income depends more on actual investment performance, whereas bigger catch-ups, lower hurdles and deal-by-deal carry favour the GP.

  1. ALowering the management fee base to invested capital after the investment periodCorrect
  2. BIncreasing the size of the GP catch-up
  3. CReplacing the hurdle rate with a lower hurdle
  4. DAllowing the GP to receive carry on a deal-by-deal basis

Explanation

Basing fees on invested capital (or net invested capital) after the investment period ties fee income to capital actually deployed, reducing the incentive to hold assets. A larger catch-up, lower hurdle and deal-by-deal carry all increase GP payouts earlier or more easily.

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