The Performance of Hedge Fund Performance Fees

Abstract

Performance-based fees in asset management contribute to the growing cost of financial intermediation. But how well do these fees align the long-run outcomes of fund managers and investors? In a large 22-year sample of hedge funds, we find that 60% of the gains on which incentive fees are paid are eventually offset by losses. As a result, the effective incentive fee rate is 50% vis-a-vis the nominal 20% rate. Overall, hedge fund fees consume 64% of the gross returns on investors’ capital and are only weakly correlated with actual long-run performance in the cross-section of funds.

Keywords: Financial Intermediation, Compensation, Incentives, Performance, Hedge Funds, Asset Management

JEL Classification: D24, G11, G23, J33