The major similarity in compensation structure for hedge funds, venture capital firm and private equity investors is that under all three fee of 2 per cent of the total investment is charged for management of the invested fund.
The compensation structure of hedge fund is two layered. The first layer includes the 2 per cent fee that is charge for the management of the fund of the invested fund. The 2 percent is charged upon the total fund invested by the investor. The fee charged under the first layer is known as fund management fee. Then comes the second layer, under which the investors are charged a fee of 20 per cent for assurance of performance of the invested fund. The 2 per cent management fee is the charge for logistical costs and trading fee. The fee is kept low to attract more number of investors but if the fund grows so large that the amount of fee charged is not enough to manage the amount of fund, then no ore funds are accepted for investment. On the other hand, the performance fee is not charged upon the amount of total investment, rather it is based on the amount of return earned by the investor by investing a certain amount of fund. However, this performance fee is not charge if the investment fund could not fetch any return. It is done to avoid double charging investors for the same amount of return earned from the investment. After recovering from the non-performing situation when the investment earns positive return again, then the performance fees is charged again only if the return amount exceeds the highest amount of return achieved previously. The previously achieved highest return is termed as high water mark. The above are the fixed component of hedge fund compensation structure. Apart from this, there is bonus terms included in the compensation structure; however, there is no assurance for bonus. Most of the hedge fund managers are not entitled for any bonus, but the hedge fund managers who are entitled for bonus invest back a portion of the earning into the hedge fund. Moreover, the investors sometimes become sceptical about the compensation structure associated with the hedge funds. On the other hand, during market volatility there is an increase in demand for the professional hedge fund managers because they are trained enough to avoid the dwindling situation of the market trend.
Similarly, for private equity and venture capital firm the structure of compensation is the alike the structure of the hedge funds. In private equity and management fee is charge too and is same as the hedge fund management fee, which is 2 per cent of the total fund invested or managed. Suppose, an investor invested $100000, then the management fee for the fund will be 2 per cent of $100000 that is $2000. Like the performance fee in the hedge fund the private equity charges carried interest, which is again calculated in the same way as the calculation of performance fee is done. It means that if an investment attracts a return of $10000, then the carried interest charged will be 20 per cent of the return, which is $2000. On the other hand, some private equity firm charges deal fees. The deal fees are the charge taken for making new investments in new companies. In private equity, there is scope for bonus too like the hedge funds. Although the markets are different for hedge funds and private equity, the compensation structure of is almost similar in both the cases. The compensation structure of venture capital is similar too and is discussed in the following lines.
The venture capital gets funds from limited partners and general partners. The limited partners are the ones that invest fund in the venture capital firm and they are mostly institutions, pension funds, insurance companies, high net worth individuals and family businesses. On the other hand, the general partners are the ones that raise funds and then manage those funds and help the venture capital in making investment decisions and in the exit of portfolio companies. For the management of the fund the venture capital takes 2 per cent of the total invested amount and for performance of the investment, a carried interest is charged on the return, which is equal to 20 per cent of the return from the fund invested. Therefore, the major similarity in the compensation structure of the three fund is in the similar structure of the fees
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