Incentive Fees: The Basic Issues

  • Record E
  • Tynan M
  • 8

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Abstract

Most money managers may now choose between three broad categories of compensation—
fixed-dollar fees, asset-based fees and incentive fees. Under a fixed-dollar fee, the manager
receives a specific sum of money for managing an account over a specific time period—for
emmple, $100,000 per year. Under an asset-hased fee (currently the most common form of
compensation), the manager receives a percentage of the market value of assets under
management, the amount of ihe fee varying with this value.
Incentive fees include those that are contingent upon account performance versus an
independent index and those based upon a percentage of the portfolio's absolute net gains
over some time period. Whatever form the incentive fee takes, the client and manager must
decide whether the fee will involve a penalty for underperformance, the length of the period
over which performance is to be measured, the relative magnitudes of the base fee and the
incentive, and whether an incentive fee is appropriate to the account.
Like any compensation scheme, an incentive fee should be fair and reasonable in light of
the manager's and client's circumstances. The fee should be clearly understood by both client
and manager. And the fee should not provide the mamiger with an inherent incentive to take
actions that may benefit the manager but may not be in the best interests of the client.

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Authors

  • Eugene E. Record

  • Mary Ann Tynan

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