A Comparative Analysis of Performance Fees
Posted: 9 Jan 2018
Date Written: January 2, 2018
Many investors pay their investment managers fees that include a base component, which is a fixed percentage amount of the fund’s assets, and a performance component, which is a variable amount that is contingent on the performance of the fund. These fee arrangements are typically referred to as performance fees, while fee arrangements that do not include a variable component are referred to as flat fees. In this paper we provide a comprehensive, ex ante comparative analysis of returns net of fees taking into account a wide range of features about the structure of the fees, the performance of the managers, and the preferences of the investor. Because the interaction of these features are complex and often subtle, we cannot adequately evaluate after-fee performance based simply on the mean and dispersion of the after-fee return nor the implied option value of the fee. Instead, we employ simulation to produce ex ante distributions of after-fee performance, and we use the certainty equivalents of these distributions to compare alternative fee arrangements.
Keywords: Certainty equivalent, Flat fee, Kinked utility, Log utility, Performance Fee, Power utility
JEL Classification: C10, C40, C60, G11
Suggested Citation: Suggested Citation