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The Gap between Desert and Entitlement: Performance Fees in Hedge Funds

51 Pages Posted: 1 Jul 2014 Last revised: 31 Jul 2015

Joe Rich

Monash University - Department of Accounting

Paul Lajbcygier

Monash University - Department of Banking & Finance

Date Written: July 31, 2015

Abstract

Hedge fund performance fees vary from 10% to 50%, with managers typically keeping 20% of the profits for themselves. Such large performance fees are unusual and provide a unique test of the efficacy of performance-based contracting. In theory, by linking a substantial amount of a fund manager’s remuneration to performance, even a loosely monitored agent such as a hedge fund manager has an incentive to produce better performance for investors. In turn, this means that investors may look at fee size as a proxy for managerial quality in the belief that in a competitive market for managerial talent, funds with higher performance-based fees attract superior managerial talent. Our focus is on the 2001–2009 period, where hedge fund managers did not change their fees once these were set at fund inception. We find that the higher a manager’s performance fee, the slightly higher the manager’s average return. However, managerial skill as measured by risk-adjusted returns is no greater for managers who enjoy large performance fees. Therefore, there is no evidence that higher performance fees are associated with managerial skill. This is of concern because for performance fees to be deserved they should result from managerial skill.

Suggested Citation

Rich, Joe and Lajbcygier, Paul, The Gap between Desert and Entitlement: Performance Fees in Hedge Funds (July 31, 2015). Available at SSRN: https://ssrn.com/abstract=2461100 or http://dx.doi.org/10.2139/ssrn.2461100

Joe Rich

Monash University - Department of Accounting ( email )

Building 11E
Clayton, Victoria 3800
Australia

Paul Lajbcygier (Contact Author)

Monash University - Department of Banking & Finance ( email )

Wellington Road
Victoria, Roodepoort 3145
Australia

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