A sharp drop in hysteresis is observed for shape memory alloys satisfying the compatibility condition between austenite and martensite, i.e. λ2 = 1, where λ2 is the middle eigenvalue of the transformation strain matrix. The present work investigates the evolution of microstructure by transmission electron microscopy as the composition of the Ti50Ni50−xPdx system is systemically tuned to achieve the condition λ2 = 1. Changes in morphology, twinning density and twinning modes are reported along with twinless martensite and exact austenite–martensite interfaces.