Carry, Carried Interest, Hurdle Rate, and High Water Mark

Definitions

These terms are most commonly heard in discussions of fees paid to managers of private investment partnerships, including hedge funds. Typically, such partnerships provide a two-part fee for their managing partners: (1) an annual fee based strictly on invested assets and (2) an incentive fee based on absolute performance. The latter fee is often referred to as the managing partner's "carry" or "carried interest." Some partnership agreements prohibit the payment of such a bonus unless performance exceeds a specified floor, also known as a "hurdle rate" (e.g., 8% net of inflation). Perpetual life partnerships that compute and pay incentive fees on a periodic basis typically specify that the managing partner shall receive a bonus only if the partnership's net assets are above their previous "high water mark," i.e., such assets' aggregate market value exceeds any earlier observations. "High water marks" prevent a manager from pocketing a bonus for good performance in a given year without first recovering any earlier absolute losses.