How Investment Management Fees Hurt Investors
35 Pages Posted: 25 Jan 2018
Date Written: May 2, 1997
A widespread concern in the investment industry is whether commonly used investment management fee arrangements encourage investment managers to act in their clients’ interests. The value to managers of a one-period call performance fee is maximized by maximizing performance volatility. This is not in clients’ interests. Maximizing performance volatility may not be optimal for managers in the long run because they can be fired. This paper describes and values one-period and long-run generic call, bull-spread, and flat fees. Their incentives are determined and compared. The approach is then generalized to any investment management fee that can be expressed as an end of period payoff pattern and to determine intraperiod incentives. For the most part, the investment management fees analyzed here fail to provide reasonable incentives to managers or probably are unacceptable to informed clients. The only exceptions are narrow rang-es of bull-spread and, to a lesser extent, flat fees. Many investment professionals may have discovered them, without the aid of formal analysis. The intraperiod incentives are consistent with managers’ observed behavior.
Keywords: investment performance, investment management fees, performance fees, investment management fee incentives
JEL Classification: G00, G02, G10, G11, G12, G13
Suggested Citation: Suggested Citation