A Reader recently forwarded to me the marketing documents of an open-end investment fund based in London. The fund had an interesting incentive fee arrangement equal to 20% * (Value at Redemption - Value at Subscription), subject to an annual hurdle rate of XYZ Benchmark + 300 basis points. The incentive fee is deferred until the client decides to pull capital from the fund.

This led me to ponder: since the General Partner doesn’t get paid any incentive fees until redemption, are the taxes payable by the General Partner associated with the incentive fee also deferred until redemption?

If so, does this mean that the fee and tax deferral constitutes a form of “free float”? It would seem so since the manager is able to continue to compound the capital that otherwise would have gone to pay incentive fees and associated taxes at the GP level (a la 401Ks or IRAs).

Interestingly, as pointed out by the Reader, perhaps that’s the reason why Berkshire Hathaway has chosen to not sell some of its long-term public holdings. The cost at sale is not only the tax bill (deferred until now), but also the loss of a form of free float, made so much more valuable by the future compounding power of Berkshire.