Egregious performance fee structures in funds management

Many investment funds have inappropriate performance fee structures - and this problem extends beyond hedge funds to include numerous long-only funds.

In simple terms, it’s wrong for a manager to charge a performance fee after delivering poor results. The challenge is to define “poor results”. A manager can generate a positive return but deliver a poor result for investors (and vice versa). A manager can even beat a market benchmark and deliver a poor result if the fund’s beta profile doesn’t align with the benchmark.

In this note, I focus on the most egregious examples of performance fee structures. In the hedge fund industry, it is standard practice to charge a performance fee without reference to a hurdle. Ideally, the appropriate hurdle/benchmark should be the cash rate; however, given that the cash rate has been relatively low over the past few decades, this omission is not a major issue.

Interestingly, although the large multi-strategy funds are often criticised for their high fees, they actually tend to employ relatively reasonable performance fee structures. There are, however, many examples of truly egregious performance fee arrangements, as outlined in this note.

The practice of funds adopting inappropriate performance fee structures is far more common in Australia than in other developed markets. While Australia adopts best practices across many industries, the funds management sector lags notably in this respect. I find this interesting given fund rating agencies play an extremely important role in Australia’s investment landscape, and you’d expect them to be on top of this issue. However, they often appear more focused on the profile and charisma of fund managers than on important considerations such as fee structures.

Hedge funds which charge a performance fee without a hurdle despite minimal or no hedging

This issue is especially prevalent in Australia. For some reason, any fund that can hedge its long exposure is classified as a hedge fund, even if the manager rarely, if ever, makes use of that capability. Because these funds are treated as hedge funds, they charge performance fees without reference to any benchmark.

This applies to some Australian “hedge” funds which have net exposures greater than 100%. When markets are up, these funds can massively underperform and still collect large performance fees.

Broadly speaking, any long/short equity fund that isn’t market neutral can deliver disappointing results for investors during bull markets while still charging high performance fees. This includes many activist funds, which often maintain net exposures close to 100%.

Long-only funds that charge a performance fee without an equity benchmark hurdle

To me, this is an egregious practice, yet some managers attempt to justify it on the grounds that their portfolios are “benchmark unaware”. In reality, there is always some relevant market benchmark against which a long‑only manager should be assessed - and any reasonable benchmark is better than none at all.

A good example is a well-known Australian long-only fund: the Collins St Value Fund. I highlight this fund because it is generally well‑rated by Australian rating agencies for its performance and active style. Personally, however, I would avoid any fund that could significantly underperform any reasonable benchmark yet still charge a high performance fee.

Long-only funds which have a high portfolio beta

This applies to some growth funds which predominantly invest in high beta stocks. Consider the Hyperion Global Growth Companies Fund. I know about this fund because Hyperion is one of Pinnacle’s most successful affiliate funds and our fund has a short position in Pinnacle (PNI AU). The Hyperion Global Growth Companies Fund has only 20 holdings and, according to the January 2026 newsletter, the portfolio beta is 1.7. Since the fund’s launch, its benchmark - the MSCI World Accumulation Index (AUD) -  has risen by approximately 350%. One would reasonably expect the fund’s performance to exceed this benchmark by a considerable margin, given its high portfolio beta. However, this isn’t taken into account when calculating the performance fee.

This is far from the most egregious practice in the funds management industry - particularly in Australia - and I’m not aware of any fund that adjusts its performance fee hurdle to account for portfolio beta. However, I wouldn’t invest in any fund which charges a performance fee and has a portfolio beta significantly greater than 1.

Funds which charge performance fees more frequently that annually

In an ideal world, funds would include a performance fee give‑back clause to address situations where a manager earns a performance fee for outperformance but subsequently underperforms. In reality, however, implementing such a mechanism is very difficult.

What is easy, however, is to charge performance fees annually rather than semi‑annually. This at least addresses situations where a manager outperforms in the first half of the year but then underperforms in the second. Most funds calculate performance fees on an annual basis, with the notable exception of Australian funds, where semi‑annual performance fees are the norm. I can’t see any justification for semi‑annual performance fee payments.

Funds which charge a performance fee and have a strong style bias

This issue is more contentious because having a successful style tilt is typically regarded as “skill” rather than “luck”. The interpretation also tends to be asymmetric: when the style tilt works, the fund manager attributes it to skill; when it doesn’t, it is dismissed as bad luck.

Many of the most successful long‑only funds over the past decade have a strong growth bias. Given that growth has generally outperformed value during this period - with the notable exception of 2022 - this positioning has proven to be a successful strategy.

I believe the strong outperformance of growth stocks has resulted in some managers accruing large fees even though their stock selection has been poor and their skill level low.

I will use the ARK Innovation ETF (ARKK US) to illustrate this point, as it’s a well-known fund and its performance is fresh in my mind after reading a recent Bloomberg article titled “Cathie Wood’s ARRK Takes Fresh Hit After Falling 50% Since Covid”. Although this fund doesn’t charge a performance fee, it attracted extremely strong inflows - and therefore generated significant management fees - on the back of the manager’s high profile and the extraordinary gains achieved in 2020. The subsequent poor performance suggests that those 2020 gains were likely due more to luck than to skill.

Undoubtedly, there are numerous long‑only funds with a strong growth bias that earned substantial performance fees based on a fortunate style bias rather than genuine manager

skill.

Funds which don’t have a high-water mark

Today, this practice is extremely rare. The only examples I’ve come across in my long career are two closed-end funds listed on the Australian Stock Exchange: Thorney Opportunities Fund (TOP) and Thorney Technologies (TEK). To make matters worse, both funds charge a performance fee every six months.

The good news is that the funds introduced a high‑water mark in 2024. Prior to this, the manager was able to charge excessive performance fees while delivering poor results for the funds’ shareholders. Given the closed‑end structure of the funds, net redemptions weren’t possible. Why the Australian regulator, ASIC, allowed this to occur is beyond me.

I’d explicitly state my view on the morality of setting up such a performance fee structure, but the billionaire founder of Thorney Investment Group, Alex Waislitz, is known to be litigious, and I don’t want to be sued.

Low breadth funds which charge a performance fee

This is a more subtle point that I left out of my original note. Let me start with something no one can disagree with: fund managers should only be paid performance fees based on skill rather than luck.

How does this pertain to breadth? The answer is that it’s very hard to distinguish between luck and skill in low-breadth strategies.

Consider a coin-tossing game. It costs nothing to play, and you have a chance of winning an attractive payout. In the first game, if you toss a coin five times and get three heads, you receive $1,000. Everyone will want to play this game since you have a 31% chance of winning.

Now consider a second, identical coin-tossing game with the same 60% success rate, but where you must toss the coin 500 times and get 300 heads. No one will want to play the second game - and not just because it takes longer to toss 500 coins. The problem is the probability of winning: it’s fallen from 31% to 0.0003%.

This illustrates the power of breadth in distinguishing between luck and skill. The coin-tossing game is entirely based on luck, but in the first game, you still have a reasonable chance of winning (and then bragging to anyone who will listen about how “skilled” you are). In the second game, you have virtually no chance of winning.

Now, let’s relate this back to funds management. Many managers like to boast about their high-conviction investing. They claim they are so good at what they do that they can take big bets on a small number of stocks and hold them for a long time. Numerous funds adopt this approach, with around 20 to 40 holdings in their portfolio and relatively little turnover. Maybe they truly are skilled - but with this low-breadth, high-conviction style of investing, it’s extremely difficult to distinguish between luck and skill. In fact, in some extreme cases you would need a track record of more than ten years to make this determination. The fact that some of these funds seek to charge a performance fee every six months is, frankly, absurd.

Finally, I'm not saying that low-breadth, high-conviction funds shouldn't charge a performance fee. I'm saying that it shouldn't be charged semi-annually and that investors should be aware they may end up paying a fee for performance driven by luck rather than skill.

Postscript

If I could wave a magic wand and change the industry, I would prohibit equity funds from charging a performance fee:

• Over any period shorter than 12 months

• Without a high-water mark

• Without an equity market benchmark as a hurdle if net exposure at any stage during the performance fee period exceeded 70%.

The last point, in particular, would be met with strong resistance from the funds management industry, largely because it would result in a significant transfer of wealth from fund managers to investors.