On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives

Fully published version of paper available at PMR: https://jai.pm-research.com/content/early/2021/05/21/jai.2021.1.135 ©2021 PMR. All rights reserved.

17 Pages Posted: 10 Sep 2020 Last revised: 3 Jun 2021

See all articles by Wei Dai

Wei Dai

Dimensional Fund Advisors

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

Savina Rizova

Dimensional Fund Advisors

Date Written: September 4, 2020

Abstract

This paper provides a robust and practical framework for assessing performance fees. The fee valuation uses standard option pricing models and therefore does not require any expected return or alpha estimate. These features make our framework easy to use, robust, and widely applicable to a variety of fee structures in practice. We discuss the incentive impact of performance fees and caution against the unintended consequences for manager behaviors. These implications are especially relevant today, as systematic investing is on the rise and asset owners are increasingly interested in the adoption of performance fees across a broader range of investment styles.

Keywords: performance fees, option pricing models, manager incentives, compensation, fee structure

JEL Classification: G23, J33, L14

Suggested Citation

Dai, Wei and Merton, Robert C. and Rizova, Savina, On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives (September 4, 2020). Fully published version of paper available at PMR: https://jai.pm-research.com/content/early/2021/05/21/jai.2021.1.135 ©2021 PMR. All rights reserved., Available at SSRN: https://ssrn.com/abstract=3686987 or http://dx.doi.org/10.2139/ssrn.3686987

Wei Dai

Dimensional Fund Advisors ( email )

6300 Bee Cave Road, Building One
Austin, TX 78746
United States

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

Savina Rizova (Contact Author)

Dimensional Fund Advisors ( email )

6300 Bee Cave Road, Building One
Austin, TX 78746
United States

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