The performance fee trap: when “success” costs you more

How performance fees actually work

A hurdle (for example 8%) means the performance fee starts only after that return. A high-water mark means the manager should not earn a performance fee again until the previous peak is recovered. A catch-up clause can give the manager 100% of the gains above the hurdle until their share is “caught up” — which can consume a surprising slice of a good year.

On CHF 1 million, a 2% management fee is CHF 20,000. A 20% performance fee on a 12% year after an 8% hurdle is another CHF 8,000 in a simple case — more if catch-up applies. Ask for a worked example on your own numbers, with and without a down year afterwards.

The double-dip problem

AUM plus performance plus underlying fund TER plus spreads can land in a 3% to 5% total-cost band in an active alternative sleeve. That is a high hurdle for the manager to beat a cheap listed portfolio. If the same firm also charges a household AUM fee on the same assets, ask whether the alternative’s performance fee is extra or included.

When performance fees backfire

A fee on upside, with little sharing of downside, invites more risk than you asked for. A flat market with a lot of trading can still generate costs even when the performance fee is zero. A lock-up after a poor year is how you pay for a decision you can no longer reverse.

Negotiating clearer terms

Cap the performance share. Require a high-water mark that does not reset quietly. Set a floor: no performance fee in a year the portfolio is down. Compare the whole package with a flat AUM fee on a listed implementation. If the manager will not put the comparison on one page, you have your answer.