A performance fee is a fee charged by some mutual funds, hedge funds or investment managers, which is contingent on the fund's or manager's performance. This fee is typically a percentage of the investment profits and is charged in addition to the regular management fee. The rationale is to align the interests of the managers with those of the investors, incentivising managers to deliver superior returns.
Performance fees often have a benchmark or hurdle rate, which is a minimum return level that the fund or manager must achieve before the fee is charged. They may also include a 'high water mark' provision, ensuring that performance fees are only charged on net profits above the highest previously achieved value of the investment.
While performance fees can motivate fund managers to achieve higher returns, they can also incentivise taking greater risks. Investors should carefully consider the fee structure, including the size of the performance fee, the benchmark used and the presence of a high water mark. It’s crucial to balance the potential for higher returns against the costs and risks associated with such fee structures.
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