Bringing clarity to performance fees for private assets in DC

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We pay the top managers in many fields, from sport to business to investment, based on the results they deliver. The better those results, the more they can charge for their services. Private market managers are no different.

Private assets are becoming more prominent in workplace pension investment portfolios, and so too are performance fees. Future Growth Capital, a joint venture between Standard Life and Schroders, estimates that over 95% of private market strategies include a performance fee. Compared with fixed management charges, these can feel unfamiliar, but they’re a standard feature of private markets. 

Understanding how performance fees work is therefore an important part of assessing value. If they’re not clearly visible, this raises important questions about where costs sit within the investment chain – or whether access to some parts of the market is being limited.

 

Why performance fees feel different for DC schemes

Performance fees have long been a feature of private markets. Typically, they come in the form of a share of profits paid to investment managers once returns exceed a defined level. 

These charges, often referred to as carried interest, are designed to align the interests of managers and investors by rewarding strong performance, providing an incentive that benefits both parties. They’re standard in private equity, venture capital and some areas of private credit, but are less familiar in DC pensions, where members are more used to fixed annual charges. This reflects the more hands-on nature of many private market strategies, compared with the largely passive strategies that have typically dominated DC investing. 

In contrast, performance fees vary depending on outcomes, can build up over time, and may not always appear immediately – factors which can make them more complex and harder to explain. Trying to avoid them completely, however, can mean limiting access to opportunities available in private markets. For corporate advisers, and other DC decision-makers, this makes clear fee disclosure an important consideration. 

 

The real challenge in performance fees for DC: design, not cost

There are several possible approaches to addressing performance fees for DC portfolios. One is to avoid them altogether, perhaps by not investing in the private asset classes with the highest performance fees, like private equity and venture capital. These are often associated with higher-growth investment strategies. The difficulty is that avoiding them can significantly narrow the range of opportunities available. 

Another approach is to accept performance fees as they arise and pass them directly through to members. While this sounds simple, it can mean individual investments trigger performance fees even when the overall private market portfolio delivers weaker results. 

There are also examples where members pay a higher annual management charge to cover performance fees - again, regardless of how the private market investments ultimately perform. Both approaches raise important questions about alignment and fairness.

So, the real question is not simply whether performance fees are used, but how they are structured. Focusing on cost alone can risk missing the most important objective: the value delivered to members after fees.

 

What good design looks like

Well-designed performance fee structures tend to share a number of characteristics that are broadly in line with evolving regulatory expectations. First, fees should be linked directly to performance, so that additional costs arise only once value has been created.

Second, fees should only apply once returns have met a clear threshold. This helps to ensure that members aren’t paying extra for more modest or expected levels of return. Instead, the focus should stay on true outperformance.

Third, there should be safeguards in place to protect members from poor outcomes. Mechanisms like high-water marks – which stop fees being charged in order to cover past losses – can help to ensure fairness over time.

Finally, transparency is critical. Members and advisers alike need to understand what they’re paying for, when they’re paying for it and why. As private market allocations grow, this level of clarity is becoming increasingly important. 

 

Understanding the trade-off between access and cost

Taken together, these considerations point to a broader trade-off. Many of the potentially higher-return opportunities in private markets come with performance fees attached. Attempting to keep costs as low as possible could therefore restrict access to parts of the market where returns have historically been.

Of course, this does not mean that higher fees are always justified. But it does mean that cost should be carefully considered alongside access – and ultimately – in the context of net investment outcomes.

 

Putting performance fees into practice

In practice, private market allocations in DC schemes are likely to build up gradually, rather than be introduced all at once. Performance fees will only arise once investments are in place and thresholds met. In the early stages, exposure – and associated fees – may be limited.

This raises a wider point about fairness, too. As allocations build up over time, charges should reflect the current level of exposure, rather than a target allocation not yet reached.

This reflects the long-term nature of private market investing and reinforces how important it is to understand how fee structures work over time. Short-term movements are unlikely to capture the full picture.

Performance fees are not new, but their role in workplace pensions is evolving. As schemes increase their exposure to private assets, the focus is shifting from whether they exist to how they’re designed and disclosed.

Like in those other fields where performance-based pay is common, the principle is straightforward: pay more when results are delivered. In private markets, the key is making sure the link between performance and reward is clear, fair and aligned with members’ interests.