The business models of most hedge fund managers provide for the management fee to cover theoperating costs of the manager, leaving the performance fee for employee bonuses. However,the management fees for large funds may form a significant part of the manager's profits.Management fees associated with hedge funds have been under much scrutiny, with severallarge public pension funds, notably CalPERS, calling on managers to reduce fees. Performance feesPerformance fees (or "incentive fees") are one of the defining characteristics of hedge funds. Themanager's performance fee is calculated as a percentage of the fund's profits, usually countingboth realized and unrealized profits. By incentivising the manager to generate returns,performance fees are intended to align the interests of manager and investor more closely thanflat fees do. In the business models of most managers, the performance fee is largely availablefor staff bonuses and so can be extremely lucrative for managers who perform well. Severalpublications publish annual estimates of the earnings of top hedge fund managers. Typically,hedge funds charge 20% of returns as a performance fee. However, the range is wide withhighly regarded managers charging higher fees. For example Steven Cohen's SAC CapitalPartners charges a 35-50% performance fee, while Jim Simons' Medallion Fund charged a45% performance fee.Average incentive fees have declined since the start of the financial crisis, with the decline beingmore pronounced in funds of hedge funds (FOFs). Incentive fees for single manager funds fell to19.2 percent (versus 19.34 percent in Q1 08) while FOFs fell to 6.9 percent (versus 8.05 percentin Q1 08). The average incentive fee for funds launched in 2009 was 17.6 percent, 1.6 percentbelow the broader industry average.Performance fees have been criticized by many people, including notable investor Warren Buffett,who believe that, by allowing managers to take a share of profit but providing no mechanism for them to share losses, performance fees give managers an incentive to take excessive risk rather than targeting high long-term returns. In an attempt to control this problem, fees are usuallylimited by a high water mark. Ironically, Mr. Buffett charged incentive fees until his firm was verylarge.As the hedge fund remuneration structure is highly attractive it has been remarked that hedgefunds are best viewed "... not as a unique asset class but as a unique ‘fee structure’."By whom?Citation? High water marksA high water mark (or "loss carryforward provision") is often applied to a performance feecalculation. This means that the manager receives performance fees only on increases in the netasset value (NAV) of the fund in excess of the highest net asset value it has previously achieved.For example, if a fund were launched at a NAV per share of $100, which then rose to $120 in itsfirst year, a performance fee would be payable on the $20 return for each share. If the next year itdropped to $110, no fee would be payable. If in the third year the NAV per share rose to $130, aperformance fee would be payable only on the $10 profit from $120 (the high water mark) to$130, rather than on the full return during that year from $110 to $130.High water marks are intended to link the manager's interests more closely to those of investorsand to reduce the incentive for managers to seek volatile trades. If a high water mark is not used,a fund that ends alternate years at $100 and $110 would generate a performance fee every other year, enriching the manager but not the investors.The mechanism does not provide complete protection to investors: A manager who has lost asignificant percentage of the fund's value may close the fund and start again with a clean slate,rather than continue working for no performance fee until the loss has been made up for. Thistactic is dependent on the manager's ability to persuade investors to trust him or her with their money in the new fund.