Why Performance-Based Fees for Mutual Funds?

An Active Alternative to Passive Investing

The last decade has seen explosive growth of passive investing. Reasons abound – lower fees, poor relative performance from active managers, introduction of ETFs, and more. Still, many investors seek the potential benefits of active management. The difference in fees between active and passive investing however, has been a stumbling block. Many investors have found it difficult to justify the higher cost of active management when better performance can’t be assured. Newly launched performance-based fees from AllianceBernstein (AB), Aperture, and others, overcome this challenge by providing a fee structure where investors pay higher fees only if an active premium is delivered. If the active manager doesn’t deliver a premium return in any year, then fees for that year are in line with passive options. The fees operate on a sliding scale – increasing as performance increases – and are capped so that they are never too high, even if a manager is generating tremendous alpha.

Aligning Fees with Mutual Fund Performance

Performance-based fees align a fund’s fees with investor experience. If the investor receives no premium return from active management, then the investor pays a passive-like fee. Only in years where the manager delivers premium returns does the investor pay a higher active fee. This fee structure reduces the volatility of excess returns since fees are lower when relative performance is bad or simply non-existent, and fees are higher only when relative performance is strong. And, even when a manager delivers a premium return to the market, the fees are typically still very competitive with traditional active mutual fund fees that charge the same rate regardless of performance. For instance, for most FlexFee Funds at AB has set the fulcrum (middle) fee of its schedule to be in the lower third of active fees for similar actively managed funds. With AB’s US High Yield FlexFee Fund, the minimum fee is considerably lower than the most popular HY ETFs and even the maximum fee is below the average active fee.

In short, today’s new performance-based fees offer investors interested in active management with a new, far more competitive fee structure that aligns fees to the mutual fund’s relative performance.