A performance fee is an incentive-based compensation that investment managers may charge, based on a percentage of the profit made on an investment for a client. The structure varies, and some managers receive a regular salary instead. Critics argue that performance fees may incentivize managers to take unreasonable risks.
A performance fee can refer generically to the fee charged for the performance of some type of service. Usually, however, it is a term used in the financial industry and may also be referred to as an incentive fee. This is because a performance fee is a type of incentive-based compensation. Depending on your service contract, investment managers may charge a performance fee, or a percentage of the profit you make on an investment for a client. The performance fee structure varies and not all investment managers are set up to receive them.
Performance fees are not the only way investment managers are compensated. Some managers receive a regular salary for their work and do not have any form of incentive-based compensation. Others are compensated through performance fees, a percentage of the fund’s earnings to encourage prudent investments, as well as management fees, a percentage of the value of the fund’s assets to compensate for the time and experience of managers. in fund management.
Those managers who are paid performance fees may not structure their pay plan in the same way. First, the rate of performance fee, usually a percentage of earnings, can vary. For example, mutual fund performance fees typically range from less than 1% to 5%, but can be as high as 15%. Hedge fund performance fees, on the other hand, can be as high as 40% or more.
The timing of performance fee payments may vary between investment managers. Fees can be paid annually, although most managers collect them quarterly or monthly. Some compensation structures that include performance fees based on asset value, not just earnings, may include high watermarks. This means that a performance fee will only be issued on the increase in value of an investment over its previous maximum value. In these cases, even if an investment generated gains if that new value is below a previously higher net value, the manager will not receive a performance fee.
There is much discussion about whether performance fee structures are fair or useful. Proponents argue that sharing the investment risk helps encourage managers to actively seek better returns on investment, since they get a reduction in those gains. Critics, on the other hand, argue that performance fees may actually incentivize managers to take unreasonable risks in the hope of big profits. These risks can not only affect the investor, but when realized on a large scale, they can affect entire markets. As a result, these critics suggest close scrutiny, if not government regulation, whether performance fees are allowed.
Smart Asset.
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