Why Most Limited Partners Should Avoid Catch-Ups

Abstract

Private fund fee structures typically contain a catch-up—a widespread limited partner preference—despite the fact that it increases fund fees and misaligns incentives. By estimating carried interest paid based on published histories of real estate opportunity fund returns, this article shows that fee structures with no catch-up and a lower hurdle have been roughly 14% less costly to limited partners than structures with a catch-up and higher hurdle. Alignment of interests is generally optimized by a more linear non-catch-up compensation structure, although IRR-focused investors may prefer a catch-up.