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Hedge Funds

See Also
Currency Exchange Rates
Hedging Risk
Currency Swap
Transaction Exposure
Exchange Traded Funds

Hedge Funds Defined

What is a hedge fund? A hedge fund is a private investment portfolio that makes aggressive speculative investments. Because hedge funds often have a very high minimum investment requirement, hedge fund investors are typically only institutional investors and wealthy individuals. The hedge fund manager manages the hedge fund investments. Because hedge funds are private – often structured as private partnerships – they are not subject to the same SEC regulations as other funds, such as mutual funds.

Hedge Fund Investing

Hedge fund investing is fairly illiquid. This is because hedge funds often require investors to commit their invested capital for a certain period of time, sometimes a year or longer. During this period the investor’s capital is locked into the hedge fund. Therefore, the investor cannot pull out the invested funds. Hedge funds often require investors to lock in their funds so the hedge fund manager can engage in complicated investments without worrying about having the capital pulled out from under him.

Costs of Hedge Funds

The costs of hedge funds include management fees and a percentage of any profit that goes to the hedge fund manager. Call this percentage of profit that goes to the hedge fund manager the hedge fund carry. Hedge fund investments often include combinations of exotic financial instruments, such as credit default swaps, leverage, options contracts, forward contracts, futures contracts, long positions, short positions, and other financial derivatives.

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Carried Interests

See Also:
Hedge Funds
Venture Capital
Current Expenditures
How to Compensate Sales Staff
Indirect Labor

Carried Interests Definition

What are carried interests? The carried interests definition is a portion of an investment fund’s annual profit that is given to the fund manager at the end of the year. Carried interests are designed to incentivize to the fund manager to achieve outstanding performance for the fund. They are often set at around 20% of the fund’s profits.

You can also call carried interest carry, or profit interests. Use the amount to compensate fund managers and general partners at private equity firms and hedge funds. The carried interest may be the primary source of compensation for the fund managers; however, it does not include any of the fund manager’s own money that he may have invested in the fund.

There may be a hurdle rate of return stipulated, as well. For instance, the policy at a private equity fund may be that all of the investors must earn at least 7% return on their initial investment. In addition, the policy may consider everything above and beyond that pure profit and may use it to compute the fund manager’s carry.

Carried Interest Example

For example, a hedge fund has $100 million of invested capital from 10 investors. The hedge fund has told the investors to expect at lease a 5% return on their investment. In addition, the fund manager will earn a 20% carry on the profits above the 5% hurdle rate. Now, motivate the fund manager to maximize the fund’s performance. Furthermore, he will earn 20% of anything above $105 million.

At the end of the year, the fund is worth $125 million. The fund made a profit of $25 million, or 25%. Let’s see how much of this profit will go to the fund manager for his efforts.

Profit the Fund Manager Gets

Ten investors contributed $10 million each to make the full amount in the fund, $100 million. Each of the investors was told to expect at least a five percent return on their investments, or $500,000 each. For all ten investors, this adds up to $5 million. This means, according to the hurdle rate, the fund manager earns 20% on anything above $105 million.

The fund made $25 million. So subtract the $5 million for the hurdle rate. That leaves you with $20 million. Now, the fund manager earns 20% of the $20 million. This turns out to be $4 million. Then distribute the remaining $16 million among the investors or use it to cover other expenses or simply reinvest it in the fund.


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carried interests, Carried Interests Definition

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