Performance fees are an accepted feature of wholesale funds. When they are drafted and implemented properly, they reward investment managers for generating strong returns and give investors confidence that they are paying only what has been clearly disclosed.
The challenge is that a performance fee is not a single concept. It is a mechanism that must operate consistently across three separate sources of truth:
- The Information Memorandum which tells investors what the fee is and how it works.
- The Investment Management Agreement which provides the legal authority for the fee.
- The financial model which performs the actual arithmetic.
If these three components are not perfectly aligned, the resulting fee may be inaccurate, legally unsupported or not what investors were told to expect. At MARQ Trustees, we routinely review fee structures and have seen firsthand how misalignment can create commercial, legal and reputational risk.
DISCLOSURE, LEGAL DRAFTING AND CALCULATION MUST MATCH
A clear explanation in the Information Memorandum is not enough on its own. The Investment Management Agreement must contain drafting that reflects the same logic and produces the same result. The financial model must then apply that logic in a way that is mathematically correct and capable of being repeated with certainty.
When any one of the three fails, the consequences can be significant. In one case, the manager’s financial model understated the performance fee by about $1.5 million because it did not correctly apply the basis of the fee described in the documents. In another, the clause in the Investment Management Agreement that purported to give rise to the performance fee was drafted in a way that, when applied literally, always produced zero. On paper there was a fee. In practice there was none.
These outcomes were avoidable. The underlying issue was not the commercial principle, but the lack of alignment between what investors were told, what was drafted and what the model calculated.
WHY THESE FAILURES OCCUR
Common causes of misalignment include:
- Explanations in the Information Memorandum prepared by marketing or structuring teams that do not reflect the precise legal drafting.
- Legal clauses written in technical language that do not follow the simplified logic presented to investors.
- Financial models prepared by analysts who apply their own interpretation of the fee rather than the actual drafting.
- Assumptions made during the drafting or modelling phase that are not tested against various performance scenarios.
Small inconsistencies can compound into major errors once capital is deployed and the calculation becomes real rather than theoretical.
THE TRUSTEE’S ROLE IN ENSURING INTEGRITY
For trustees, alignment of performance fee mechanics is not a formality. It is essential to ensuring that:
- Investors are charged only what they have been told they will be charged.
- The legal basis for the fee is defensible and compliant.
- The model produces reliable, repeatable outcomes that match the documents.
- Managers avoid remediation, disputes and reputational damage associated with incorrect fee calculations.
All three components must be examined together.
A BETTER WAY FORWARD
The most effective approach is to treat the Information Memorandum, the Investment Management Agreement and the financial model as a single system rather than separate tasks performed by different contributors. This means:
- Drafting the fee structure in plain language first.
- Translating that logic into precise legal terms without adding or losing meaning.
- Building the financial model using the same logic, tested against multiple scenarios.
- Completing a final cross check to confirm that all three produce the same result.
This process is simple, practical and prevents the types of errors that have caused significant issues in the past.
CONCLUSION
Performance fees only work when everything lines up. If the disclosure, the legal drafting and the model differ by even a small degree, the fee output will be wrong. For trustees and advisers, ensuring that these elements align is not only good practice, it is core to investor protection and good governance.
