The fee structure of an investment fund is more than a contractual arrangement: it is a measure of trust between the fund manager and the investor. Few things frustrate clients more than paying a performance fee in a year with a negative total return, even if the manager has outperformed the benchmark.
A sound fee structure is therefore built on fairness, transparency, and alignment of interests. In this article, we discuss the most common fee structures in hedge funds and private equity funds, highlight which choices build trust and which undermine it, and outline the environment in which fund managers operate today.
For decades, the classic 2/20 structure has been the standard in hedge funds: a 2% management fee and a 20% performance fee. This model has provided fund managers with long-term stability and a strong incentive to generate returns, but it is increasingly under pressure. Investors and regulators are taking a more critical look at the relationship between fees and performance.
What investors value are mechanisms that provide protection and transparency. A perpetual high-water mark prevents a fund manager from charging performance fees again before previous losses have been recovered. A hurdle rate ensures that performance fees are only payable once returns exceed a predefined minimum threshold (for example, 8% per year). There is also growing support for lower fixed fees and a stronger focus on performance, such as a 1% management fee instead of 2%.
On the other hand, certain structures tend to create distrust. Resetting the high-water mark is often perceived as unfair, as investors may be required to pay performance fees again even though their portfolio has not fully recovered. Tiered performance fee structures also meet resistance. For example:
In theory, this may incentivize stronger performance, but in practice it mainly creates confusion. The more complex the model, the faster investors lose confidence.
In private equity, the focus is on carried interest, a profit-sharing arrangement in addition to the annual management fee. Carry is typically 15% to 20% of profits above the hurdle rate, also referred to as the preferred return. The method of distribution largely determines how fairness and transparency are perceived.
Under the deal-by-deal method (American waterfall), the fund manager receives carry as soon as an investment is sold at a profit, even if the fund as a whole is still generating losses. The manager benefits early, while any later losses fall entirely on investors. Without protective mechanisms such as a clawback, which allows excess carry payments to be recovered later, investors often view this approach as unfair and lacking transparency.
The whole-of-fund method (European waterfall) works the other way around: carry is only distributed once the fund as a whole has exceeded the preferred return. Investors therefore first receive their full invested capital plus the agreed minimum return before the manager is entitled to share in the profits. This approach aligns more closely with investor interests and is generally seen as fairer and more transparent.
Investors also value additional provisions such as clawback clauses, which ensure that the fund manager ultimately does not receive more than what is justified based on the overall fund performance. As with hedge funds, simplicity and transparency strengthen trust, while complex or one-sided structures undermine it.
Fee structures are defined in fund documentation, but in practice the bar is higher than mere legal compliance. Fund managers must be aware of several factors that directly impact the sustainability and acceptability of their fee structure.
A first key factor is increasing regulatory scrutiny. By April 2026, EU Member States must have implemented AIFMD II. This directive requires fund managers to demonstrate that their fee structure is proportionate and in the best interest of investors. Compliance is therefore no longer only about meeting formal requirements, but also about the actual reasonableness of fees.
A first key factor is increasing regulatory scrutiny. By April 2026, EU Member States must have implemented AIFMD II. This directive requires fund managers to demonstrate that their fee structure is proportionate and in the best interest of investors. Compliance is therefore no longer only about meeting formal requirements, but also about the actual reasonableness of fees.
Finally, competitive pressure continues to increase. Investors increasingly compare fee structures and are quicker to switch to alternatives when a fund appears too expensive or overly complex. Transparency and simplicity are therefore not only compliance considerations, but also strategic competitive advantages.
Whether in hedge funds or private equity, investors value fairness, simplicity, and transparency. Fee structures that protect against double fees, focus on genuine value creation, and balance interests build trust and strengthen long-term competitiveness.
In contrast, structures that are overly complex or one-sided may be legally defensible but undermine investor confidence and increase reputational risks.
The message for fund managers is clear: do not only choose what is legally possible, but above all what feels fair and transparent. That is the key to success in a market where trust is both scarce and essential.
