by later allocations, where investor 1 and investor 2 receive a larger por-
tion of future realized gains. Hedge funds carry the amount in different
ways, depending on the set of rules they apply to perform the allocation.
Need for More Complete Allocation Rules
The allocation in the preceding
example is relatively simple because all three partners had gains in their
memo balances and because they collectively had larger gains than the
$30,000 realized gain. Allocation rules must be complete enough to deal
with all possible situations.
For example, it is typical to allocate gains to partners who have posi-
tive memo balances and omit partners from the allocation who have nega-
tive memo balances. Similarly, losses may be applied proportionately to
partners having negative memo balances, omitting allocations to partners
with gains in their memo balances.
Sometimes, partners have positive memo balances but the partnership
realizes gains greater than the beginning memo balances. In the case, the
partnership may allocate part of the gain to match gains in memo ac-
counts. Realized gains allocated when no partners have positive memo bal-
ances are usually based the economic ownership percent of the partners.
Similarly, realized losses may be allocated according to economic owner-
ship when no partners have negative memo balances.
Other partners may apply the realized gains and losses to the part-
ners with the oldest entries in the memo accounts. This method is some-
times called first in, first out (FIFO). In the preceding allocation example,
investor 1 and investor 2 would receive some of the realized gain based
on their memo gains in January. The realized gain ($30,000) exceeds the
January memo entries ($27,500--the total of all the entries in Table
170
HEDGE FUND COURSE
TABLE 10.5
Updated Memorandum Balances

^a$98 = $9,750 (memo balance from February--Table 10.3b) ­
$9,652 (gain allocated in Table 10.4c).
^b$147 = $14,625 (memo balance from February--Table 10.3b)
­ $14,478 (gain allocated in Table 10.4c).
^c­$245 = $5,625 (memo balance from February--Table 10.3b)
­ $5,870 (gain allocated in Table 10.4c).
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