Analysis of Option-Like Fund Performance Fees in Asset Management via Monte Carlo Actuarial Distortion Pricing

Abstract

A detailed analysis of management and performance fees for asset managers and investment funds is undertaken. Whilst, fund fees are considered as a cost of capital for investors, the structuring of such fee mechanisms in a fund can also influence a fund manager’s decisions and investment strategy, thereby also influencing the investment performance of the investors funds. The study undertaken will allow for an assessment of the effect of fee structures and the potential for asymmetric incentives to arise that may promote adverse risk taking behaviours by the fund manager, to the detriment of the investor or retiree who places a portion of their retirement savings into such a managed fund with such fee structures.

As such, understanding the mechanism of fee charging as well as pricing the fees correctly is vital.
An exploration of the application of actuarial distortion pricing methods for complete and incomplete market valuation is performed on a variety of path dependent option-like performance fee structures for various funds in the European and American markets. Furthermore, several scenario analysis and sensitivity studies are undertaken. The class of Net Asset Value (NAV) models adopted are Levy processes and the pricing is performed via Monte Carlo techniques.

Keywords: Performance-fee pricing; Mutual fund; Distortion Pricing; Monte Carlo, Retirement Savings Costs