Beyond the Headlines and into the Footnotes

While most investors grasp the basics of management fees (the steady operational charge) and performance fees (the reward for outperformance), the real intrigue lies in the layers beneath – the fine print, the variations, and the subtle mechanisms that can have a substantial impact on returns to the investor. Consider, for instance, fees levied on gross (inclusive of fund leverage) rather than net assets, performance fees calculated on unrealized “paper” gains, or protective clauses like high watermarks that determine when such fees truly apply – these elements, among others, introduce complexities that we will explore throughout the Understanding Fees article series.

This checklist distills those insights into a practical tool for your due diligence process. Think of it as your guide through the fine print, from management fee calculations on gross versus net assets, to performance incentives with their high watermarks and clawbacks, to the often-overlooked operational expenses that add up over time. Use it when evaluating fund opportunities, benchmarking against peers, and assessing whether the economics truly align with your interests or simply extract costs over the fund's indefinite lifespan.

Investor Checklist: Key Fee Considerations

1. Management Fee Basis: Examine whether fees are calculated on gross assets (including leverage) or net assets; prefer net if leverage risks aren't adequately compensated, and calculate the effective cost using examples from the prospectus to gauge impact on returns.

2. Management Fee Rates and Structures: Review the annual rate (typically 0.5-2%) and structures like tiered scales decreasing with AUM. Ensure rates justify services and liquidity; higher ones should deliver clear value.

3. Performance Fee Rates and Triggers: Review the rate (typically 0-20% of profits above a hurdle) and determine if fees apply to realized gains only or include unrealized "paper" profits from valuations. Balance risks of premature payouts against manager alignment in illiquid assets; ensure strong protections are in place.

4. Waterfall Structures: Evaluate European-style (whole-fund) vs. American-style (deal-by-deal) approaches to profit distributions and manager payouts. Favor European for stronger safeguards against misalignment, though the perpetual nature of evergreen funds adds complications here – clarify how profitability is measured in funds without a fixed end, and evaluate accounting methods.

5. Make-Whole Provisions: Ensure provisions guarantee full capital recovery plus hurdle rates before manager payouts, with adjustments for redemptions; avoid weak versions that only cover principal and check for equitable treatment across investors.

6. Hurdle Rates: Aim for 6-8% thresholds, ideally floating (e.g., SOFR-linked). Higher rates guard against easy triggers on modest gains; confirm competitive catch-ups.

7. High Watermark Provisions: Consider perpetual, non-resetting watermarks to prevent fees on loss recoveries; verify that NAV must exceed prior peaks before charges apply, protecting against cyclical market rebounds.

8. Clawback Mechanisms: Look for enforceable clawbacks (e.g., escrows) for excess fees on reversals. They promote accountability in open-ended funds; assess review frequency.

9. Administrative and Operational Expenses: These include ongoing costs like accounting, legal, custody, audits, and compliance (typically 0.1-0.5% of AUM). Review their contribution to the Total Expense Ratio (TER), the fund's overall annual operating cost as a percentage of assets; review caps to limit escalations, manager reimbursements for offsets, and itemized breakdowns.

10. Leverage-Related Expenses & Ratios: Assess borrowing interest and terms. Ensure leverage amplifies returns sufficiently to offset costs. Review leverage ratios and compare to peers.

11. Acquired Fund Fees and Expenses (AFFE): In multi-manager setups, assess layered fees from underlying funds that can add up. Compare to single-manager options or seek to mitigate with lower-fee co-investments or fee waivers.

12. Organizational and Offering Expenses: Organizational and offering expenses refer to the upfront costs associated with establishing and launching the fund. Confirm amortization over 3-5 years and any caps; ensure they're not excessively passed through, diluting early returns in new funds.

13. Subscription and Redemption Fees: Review one-time charges (e.g., 1-2% at entry for subscriptions, 0.5-2% at exit for redemptions); evaluate against liquidity provisions like redemption gates and check for waivers or declining scales to minimize penalties.

14. Overall Fee Impact: Simulate scenarios with market volatility to model total fee drag on net returns; benchmark the full TER against peers.

15. Reporting and Transparency: Seek detailed, audited fee disclosures quarterly. Granular reporting fosters trust; avoid opacity that conceals risks.

Navigating fees in evergreen funds demands vigilance: these perpetual structures combine features of open-end funds with private-market complexities, often layering costs that erode long-term returns. Scrutinize management fees for basis and scalability, performance fees for protections like high watermarks and clawbacks, and ancillary expenses – from administrative costs to interest expense – for transparency and caps. This empowers alignment with funds focused on value creation, not fee extraction. As you apply the checklist, remember: the aim isn't the lowest fees, but economics that ensure true interest alignment, strong safeguards, and clear structures for sustained net returns.