A fee schedule is a contract about how outcomes are shared, and reading it as a single number is how clients end up surprised. Price it at three outcomes instead, one bad, one flat and one good, and the structure reveals itself immediately.
How do the three fee structures work?
Ad valorem fees charge a percentage of assets. The manager's revenue is nearly independent of performance, which makes it the simplest structure to administer and the one with the weakest incentive alignment. Its hidden feature is that the fee falls in bad years and rises in good ones, in absolute money, simply because assets move; so an ad valorem fee is already mildly performance-linked, just very weakly.
Symmetric performance fees, sometimes called fulcrum fees, adjust a base fee up and down around a benchmark. A structure of 0.75 percent base plus or minus 20 percent of the return relative to an 8 percent benchmark charges 3.465 crore on a 100 crore mandate that returns 20 percent gross and zero on one that loses 10 percent, because the negative adjustment exceeds the base and the total floors at zero. This is the structure with the cleanest alignment, and it is the one clients ask for least, because the good years hurt.
Asymmetric performance fees charge a management fee plus a share of gains with no symmetric refund. Two features do the real work. A hurdle rate means the performance fee applies only above a threshold, which stops a manager being paid for the risk-free rate. A high-water mark means losses must be earned back before any further performance fee is charged, which stops a manager being paid twice for the same gain. A structure of 1.00 percent plus 15 percent above a 6 percent hurdle charges 3.20 crore at plus 20 percent gross, 1.025 crore at plus 5 percent and 0.95 crore at minus 10 percent.
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How should you compare fee structures?
Worked Example 4 prices all three at all three outcomes and then runs a two-year path, and the path is what surprises people. Over a year at minus 10 percent gross followed by a year at plus 20 percent, the client ends up with 105.35 under the flat fee, 104.88 under the symmetric fee and 105.75 under the asymmetric one. The ranking over the path differs from the ranking at every single-year outcome, because the fee changes the base on which the next year compounds. A fee comparison run at one outcome is not a fee comparison.
Three details decide real negotiations and all three are worth asking about explicitly. Whether the performance fee is measured against a benchmark or against zero, because a manager paid 20 percent of an absolute return in a year the index rose 25 percent has been paid for beta. Whether the high-water mark resets, and on what event, because a mark that resets after a bad year is not a high-water mark. And whether the fee is charged on committed or invested capital, which in private structures changes the effective rate by more than the headline number ever does.