What does carried interest represent in investment management?

Carried interest refers to a share of the profits that the general partners of a private equity fund or hedge fund receive as compensation, typically above a certain threshold or minimum return that must be achieved before the general partners can receive this share. This arrangement aligns the interests of the fund managers with those of the investors, as the managers only benefit from carried interest if they generate profits that exceed the threshold return for investors. It serves as an incentive for fund managers to maximize the performance of the invested capital, as their earnings are directly tied to the success of the investment strategy.

The nature of carried interest is such that it differentiates from fees charged, interest on borrowed funds, or penalties, making the correct understanding of it crucial for comprehending investment management compensation structures.