Performance Fee Crystallisation and Equalisation

A hedge fund charging a "20% performance fee" needs to answer a question that sounds simple but isn't: 20% of what, and when does the manager actually get paid it? The fund's NAV moves every day, so profit could technically be calculated at any moment. Crystallisation is the term for the specific date on which unrealized performance-fee accrual becomes real — the manager's fee is locked in and paid out (or added to their capital account), and the high-water mark resets from that point forward. Most funds crystallise annually, though some do it quarterly or even monthly, and the frequency is a real economic term investors negotiate.

The harder problem is fairness across investors who bought in at different times. Imagine two investors in the same fund: one joined in January when the NAV was $100, another joined in July when the NAV was $110 after a strong first half. If the fund crystallises once a year based on the fund's overall gain, the July investor would effectively be charged a performance fee on $10 of NAV appreciation that happened before they even invested — money they never made. Equalisation exists to fix exactly this, by tracking each investor's own personal high-water mark and cost basis separately, so performance fees are only ever charged on gains that investor individually experienced.

There are a few ways funds implement equalisation in practice, the most common being the "equalisation factor" or "series accounting" method, where each subscription is issued its own share series with its own high-water mark that later merges back into the main series once fees have been trued up. The details are mechanical, but the principle investors should check is simple: does the fee I pay depend only on my own gains, or could I be cross-subsidizing another investor's fee bill because we happened to invest at different NAVs?