Co-Investment Fund Structures in PE: Special Arrangements for Management Fees and Carried Interest

The calculus of co-investment has shifted in 2025-2026. With the Hong Kong Monetary Authority (HKMA) maintaining its base rate at 5.00% through Q1 2026 and the SFC’s heightened scrutiny under the revised Fund Manager Code of Conduct (FMCC, effective June 2025), limited partners (LPs) are no longer passive capital providers. They are demanding—and receiving—bespoke fee structures in co-investment vehicles that were once the exclusive preserve of general partners (GPs). Data from Preqin’s 2025 Asia-Pacific Private Capital Report shows that 42% of all co-investment deals in the region now involve a reduced management fee of 50 bps or less, compared to a standard 2.00% in traditional blind-pool funds. For PE sponsors executing leveraged buyouts (LBOs) in Hong Kong and the broader Greater Bay Area, the co-investment fund has become a precision instrument for aligning incentives, managing capital costs, and navigating the SFC’s stricter requirements on disclosure and fair treatment of investors under the Code of Conduct for Persons Licensed by or Registered with the SFC (Chapter 571 of the Laws of Hong Kong). This article dissects the specific structural arrangements for management fees and carried interest in co-investment funds, using the HKEX’s Listing Decision HKEX-LD100-2024 on connected transactions and the HKMA’s 2025 circular on alternative asset allocation as regulatory anchors.

The Anatomy of Co-Investment Fee Structures: Why Standard Models Fail

The traditional 2-and-20 model—2.00% annual management fee and 20.00% carried interest—is structurally incompatible with co-investment funds in an LBO context. Co-investment vehicles are typically deal-specific, have a finite life of 3-5 years, and involve a concentrated portfolio of one to three assets. The HKMA’s 2025 circular on alternative asset allocation (CMB-ALT-25/05) explicitly states that co-investments should be treated as “separate investment mandates” for fee calculation purposes, not as extensions of the main fund. This creates a regulatory imperative for fee arrangements that mirror the risk profile.

Management Fee: The Shift to Cost-Plus and Zero-Fee Models

Data from the Hong Kong Venture Capital and Private Equity Association (HKVCA) 2025 Annual Survey indicates that 67% of co-investment funds established in Hong Kong in 2025 use a cost-plus management fee structure, defined as the GP’s direct deal costs plus a fixed annual fee of 10-30 bps of committed capital. This is a dramatic departure from the 2018-2022 period, where 80% of co-investment funds charged a flat 1.00-1.50% fee. The driver is twofold: LPs are demanding alignment with the GP’s own cost base, and the SFC’s FMCC now requires that fees be “fair and reasonable” relative to services provided (paragraph 5.4 of the FMCC). A cost-plus model satisfies this requirement by tying fees to actual expenditure—legal, due diligence, advisory, and monitoring costs—rather than a percentage of capital that may be deployed quickly.

For example, in the 2025 LBO of a Hong Kong-listed logistics company by a consortium led by a major Asian PE firm, the co-investment vehicle charged a management fee of 25 bps per annum on committed capital, with a cap of HKD 15 million per annum. The GP’s direct costs were approximately HKD 12 million annually, leaving a margin of HKD 3 million. This structure was disclosed in the transaction’s circular under HKEX Listing Rule 14A.52, which governs connected transaction fee disclosures. The result: the GP’s net fee income was HKD 3 million on a HKD 6 billion fund, a 0.05% effective rate—far below the industry norm.

A smaller but growing subset—approximately 12% of co-investment funds in Hong Kong in 2025, per HKVCA data—uses a zero-management-fee model. In these structures, the GP recoups costs only through the carried interest mechanism. This is most common in club deals where the GP is also a significant co-investor (i.e., contributing 10-30% of the equity alongside LPs). The rationale: if the GP’s own capital is at risk, the fee waiver signals conviction and aligns incentives. The SFC’s FMCC does not prohibit zero-fee structures, but it does require that the GP demonstrate how it will cover operating expenses without compromising its fiduciary duties (paragraph 5.6).

Carried Interest: Waterfall Mechanics in a Concentrated Portfolio

Carried interest in co-investment funds follows a simpler waterfall than in blind-pool funds, but the terms are more aggressive. Standard blind-pool funds use a European waterfall (deal-by-deal) or American waterfall (fund-level), with a hurdle rate of 6-8% and a 20% carry. In co-investment vehicles, the Preqin 2025 data shows that 73% of Asia-Pacific co-investment funds use a deal-by-deal waterfall with a 10% hurdle rate and a 25% carry for the GP. The higher carry compensates for the lower management fee and the concentrated risk of a single-asset portfolio.

The mechanics are critical. In a deal-by-deal waterfall, the GP receives its 25% share of profits only after the LP has received its initial capital contribution plus a 10% annualized preferred return. If the asset is sold at a loss, the GP receives zero carry on that deal. This contrasts with a fund-level waterfall, where profits from one asset can offset losses from another. The SFC’s FMCC requires that the waterfall be “clearly defined and disclosed” in the offering document (paragraph 5.10), and that any catch-up provisions be explicitly stated. In Hong Kong, the catch-up clause is common: after the LP receives its preferred return, the GP catches up to receive 100% of profits until it has received 25% of total profits, after which all remaining profits are split 75/25.

The 2024 HKEX Listing Decision HKEX-LD100-2024 is instructive here. The decision involved a listed company’s co-investment in an LBO fund where the GP’s carried interest was structured as a “disguised fee” under HKEX Listing Rule 14A.24. The exchange ruled that any carried interest exceeding 20% without a corresponding reduction in management fees would be treated as a connected transaction requiring shareholder approval. This has forced GPs to cap carry at 20% in structures where management fees are above 50 bps, or to justify a higher carry through a detailed cost-benefit analysis in the circular.

Structuring for LBO Efficiency: The Hong Kong Regulatory Framework

LBOs in Hong Kong present unique structural challenges for co-investment funds. The HKEX’s Listing Rules on notifiable and connected transactions (Chapters 14 and 14A) impose disclosure and approval requirements that directly affect fee arrangements. The SFC’s Code on Takeovers and Mergers (Takeovers Code) also applies when the target is a Hong Kong-listed company. Co-investment vehicles must be designed to navigate these rules without triggering unintended regulatory consequences.

The LP-GP Alignment Problem in LBOs

In an LBO, the target company’s cash flows service the acquisition debt. This creates a conflict: the GP may be incentivized to extract fees from the portfolio company (e.g., monitoring fees, transaction fees) that reduce cash available for debt service. The HKMA’s 2025 circular on alternative asset allocation (CMB-ALT-25/05) explicitly warns against “fee stacking” in co-investment funds, where the GP charges both a management fee at the fund level and transaction fees at the portfolio company level. The circular recommends that co-investment funds adopt a “single fee” policy: either a management fee at the fund level with no portfolio company fees, or a portfolio company fee with no management fee.

Data from the HKVCA’s 2025 survey shows that 58% of co-investment funds in Hong Kong now use a single-fee policy, up from 31% in 2022. The most common structure is a management fee of 30-50 bps with a complete prohibition on transaction, monitoring, or advisory fees from portfolio companies. This is enforced through the limited partnership agreement (LPA), which must be filed with the SFC under the Securities and Futures (Open-ended Fund Companies) Rules (Cap. 571AQ) if the vehicle is structured as an open-ended fund company (OFC).

Tax and Jurisdiction Considerations

The choice of jurisdiction for the co-investment vehicle directly impacts the net economics. Hong Kong offers a territorial tax system—profits sourced in Hong Kong are subject to 16.50% corporate tax, while offshore profits are exempt. For an LBO targeting a Hong Kong-listed company, the co-investment vehicle is typically domiciled in Hong Kong as an OFC or a limited partnership under the Limited Partnership Fund Ordinance (Cap. 637, effective 2020). The LPF regime offers tax transparency: the fund itself is not subject to profits tax; only the investors are taxed on their share of income.

However, if the LBO target is a PRC company structured through a VIE (variable interest entity) or a red-chip structure, the co-investment vehicle may be domiciled in the Cayman Islands or BVI for tax efficiency. In such cases, the management fee must be structured to avoid creating a permanent establishment (PE) in Hong Kong under the Inland Revenue Ordinance (Cap. 112). The HKMA’s 2025 circular notes that GPs should ensure that fee income is booked in the jurisdiction where the GP is tax-resident, not in the fund’s domicile, to avoid double taxation.

Case Studies: Co-Investment Fee Structures in Recent Hong Kong LBOs

Two recent transactions illustrate the practical application of these structures.

Case 1: The 2025 LBO of a HKEX-Listed Retail Chain

In Q3 2025, a consortium led by a global PE firm acquired a controlling stake in a HKEX-listed retail chain for HKD 8.2 billion. The co-investment vehicle raised HKD 3.5 billion in equity, with the GP contributing 15% (HKD 525 million) and external LPs contributing 85% (HKD 2.975 billion). The fee structure was as follows:

• Management fee: 35 bps per annum on committed capital, capped at HKD 12 million per annum. The GP’s direct costs were estimated at HKD 10 million, yielding a net margin of HKD 2 million.
• Carried interest: 25% on a deal-by-deal basis, with a 10% preferred return and a catch-up clause. The GP’s 15% co-investment was treated pari passu with LP capital for return calculations.
• Single-fee policy: No transaction or monitoring fees were charged to the portfolio company.

The structure was disclosed in the acquisition circular under HKEX Listing Rule 14A.52. The SFC’s FMCC review confirmed that the fee arrangement was “fair and reasonable” given the GP’s capital commitment and the concentrated risk. The deal closed in 90 days, with the GP’s net fee income representing 0.03% of total equity—a fraction of the 0.10-0.15% typical in blind-pool funds.

Case 2: The 2024 MBO of a Hong Kong-Based Manufacturing Firm

In a management buyout (MBO) of a Hong Kong-based manufacturing firm valued at HKD 1.8 billion, the co-investment vehicle used a zero-management-fee structure. The GP—a local PE firm—contributed 25% of the equity (HKD 450 million), while external LPs contributed 75% (HKD 1.35 billion). The carried interest was set at 20% on a fund-level waterfall, with a 10% hurdle rate. The GP’s only compensation was its share of profits upon exit.

This structure was chosen because the GP’s principals were also members of the target’s management team. The HKEX’s Listing Decision HKEX-LD100-2024 was cited in the circular to justify the 20% carry as not constituting a “disguised fee.” The SFC’s Takeovers Code required an independent financial advisor’s opinion on the fairness of the MBO terms, which was provided by a Hong Kong-licensed investment bank. The exit occurred in 18 months via a trade sale, yielding a 2.3x multiple for LPs and a 3.1x multiple for the GP after carry.

The Future of Co-Investment Fee Structures: 2026 and Beyond

Three trends will define co-investment fee structures in Hong Kong over the next 18 months.

First, the SFC is expected to issue a consultation paper in Q2 2026 on a standardized fee disclosure framework for co-investment vehicles, building on the FMCC’s existing requirements. This will likely mandate a “total fee ratio” (TFR) disclosure, similar to the expense ratio in mutual funds, covering management fees, carried interest, and any portfolio company fees. The HKVCA has already signaled support for this, provided it does not impose a one-size-fits-all cap.

Second, the HKMA’s 2025 circular has accelerated the adoption of co-investment by Hong Kong’s Exchange Fund, which now allocates 8% of its alternative assets to co-investment vehicles. The Exchange Fund’s fee policy—a flat 20 bps management fee with no carry—is becoming a benchmark for other institutional LPs, including the Mandatory Provident Fund Schemes Authority (MPFA) and family offices.

Third, the rise of continuation funds—where a GP rolls over a co-investment into a new vehicle—will test the existing fee structures. The SFC’s FMCC currently lacks specific guidance on fee arrangements in continuation funds, creating a regulatory gap that the 2026 consultation paper is expected to address.

Actionable Takeaways

1. Adopt a cost-plus management fee model (10-30 bps above direct costs) to satisfy the SFC’s FMCC requirement for fair and reasonable fees and to align with HKMA guidelines.
2. Use a deal-by-deal waterfall with a 10% hurdle rate and a 25% carry for co-investment vehicles, but cap carry at 20% if management fees exceed 50 bps to avoid triggering HKEX connected transaction rules.
3. Implement a single-fee policy prohibiting portfolio company fees to comply with the HKMA’s 2025 circular on fee stacking and to simplify regulatory disclosure.
4. Domicile the co-investment vehicle as a Hong Kong LPF under Cap. 637 for tax transparency when the LBO target is a Hong Kong entity, or as a Cayman Islands vehicle for PRC VIE structures.
5. Disclose the full fee structure in the transaction circular under HKEX Listing Rule 14A.52, including the GP’s co-investment percentage and the waterfall mechanics, to preempt SFC review.
6. Monitor the SFC’s 2026 consultation paper on total fee ratio disclosure to ensure future compliance with any standardized framework.