The Costs and Benefits of Performance Fees in Mutual Funds

Funds with performance fees have annual net risk-adjusted returns of 0.50% below other funds, a result mostly due to funds without a stochastic benchmark against which performance is measured and funds with a benchmark that is easy to beat. For other funds, there is no evidence of underperformance. Performance fee funds charge total expenses, including the performance fee, that are substantially higher than those of other funds. Investors are more likely to punish poor performance in funds with performance fees than in other funds. Our results indicate that even when fees are less regulated, investors can generally be relied upon to make the right choices, but that there are a subset of funds where performance fees are employed to extract additional fees from investors.