The fee structure of an investment fund is more than a contract: it is a barometer of trust between fund manager and investor. Nothing frustrates a client 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 about fairness, transparency, and alignment of interests. In this article, we discuss the main fee structures in hedge funds and private equity funds, show which choices inspire trust and which undermine it, and outline the playing field in which fund managers operate today.
Hedge funds
For decades, the classic 2/20 structure has been the standard for hedge funds: a 2 percent management fee and a 20 percent performance fee. This model has provided stability and return incentives for managers for many years, but it is now under pressure. Investors and regulators are scrutinizing the balance between costs and performance more critically.
What investors value are mechanisms that provide protection and transparency. A perpetual high-water mark prevents a manager from receiving fees again before earlier losses are recouped. A hurdle rate ensures that performance fees are only payable above a predetermined minimum return (for example, 8 percent per year). Support is also growing for lower fixed costs and a greater emphasis on performance, such as 1 percent management fee instead of 2 percent.
By contrast, structures that spark distrust include resets of the high-water mark, which are often seen as unfair because investors must pay again while their portfolio has not fully recovered. Tiered performance fees also face resistance. For example:
- on the first 20 percent return, a 20 percent performance fee applies;
- above 20 percent return, the fee rises to 30 percent.
In theory, this could incentivize performance, but in practice it mainly creates confusion. The more complex the model, the faster investors lose confidence.
Private equity funds
In private equity, the focus is on carried interest, a profit share in addition to the annual management fee. The carry is typically 15 to 20 percent of profits above the hurdle rate, also called preferred return. The payout method largely determines perceptions of fairness and transparency.
Under the deal-by-deal method (US waterfall), the manager receives carry as soon as an individual investment is sold profitably, even if the fund as a whole is still loss-making. The manager benefits early, while later losses fall entirely on investors. Without protection mechanisms such as clawback provisions—where overpaid carry is reclaimed afterwards—investors see this as unfair and opaque.
The whole-of-fund method (European waterfall) works the other way around: carry is only paid once the fund as a whole has outperformed the preferred return. Investors first receive their full capital back plus the agreed minimum return before the manager can share in the profits. This approach better aligns with investors’ interests and is seen as fairer and more transparent.
Investors also appreciate additions such as clawback clauses, which guarantee that the manager ultimately receives no more than is justified based on total fund results. As with hedge funds, simplicity and transparency build trust, while complex or one-sided structures undermine it.
Implications for fund managers
The fee structure is documented in fund agreements, but in practice the bar is set higher than mere legal correctness. Fund managers must be aware of several factors that directly influence the sustainability and acceptance of their fee structure.
A first important factor is increased regulation. As of 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 interest of the investor. Compliance will no longer be only about formal legality, but also about the actual fairness of fees.
Reputational risk is another factor. Even legally correct fee structures can cause major reputational damage when investors feel they are overpaying. In a sector built on trust, this can have disastrous consequences.
Finally, there is growing competitive pressure. Investors increasingly compare fee structures and switch more quickly to alternatives if a fund appears too expensive or too complex. Transparency and simplicity are therefore not only compliance matters, but also strategic competitive advantages.
Conclusion
Whether in hedge funds or private equity, investors value fairness, simplicity, and transparency. Fee structures that prevent double charging, emphasize true value creation, and balance interests build trust and strengthen long-term competitiveness.
On the other hand, overly complex or one-sided structures—while legally defensible—undermine trust and increase reputational risks.
The message for fund managers is clear: do not only choose what is legally permissible, but above all what feels fair and transparent. That is the key to success in a market where trust is scarce and crucial.
Jesper Boelrijk is head of fund accounting at AssetCare. AssetCare supports fund managers in setting up, ensuring compliance, and administering their funds. AssetCare is part of the expert panel of Investment Officer.