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Understanding Fee Structures in the Asset Management Business

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  • Anthony W. Lynch
  • David K. Musto

Abstract

This paper considers the economic role of fees in aligning the incentives of money managers with those of investors. We examine a simple model in which manager effort (or investment in human and physical capital) is observed by the investor prior to her investment decision, but is not verifiable. This setup creates a positive economic role for net asset value (NAV) as a contracting variable and thus provides an explanation for the widespread use of contracts based on NAV in both the mutual and hedge fund industries. We also provide an explanation for why hedge funds use asymmetric performance fees while mutual funds typically charge a fixed fraction of NAV (even though 'fulcrum' performance fees are available).

Suggested Citation

  • Anthony W. Lynch & David K. Musto, 1997. "Understanding Fee Structures in the Asset Management Business," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-050, New York University, Leonard N. Stern School of Business-.
    • Handle: RePEc:fth:nystfi:98-050
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    Cited by:

    1. Emilio Barucci & Gaetano Bua & Daniele Marazzina, 2018. "On relative performance, remuneration and risk taking of asset managers," Annals of Finance, Springer, vol. 14(4), pages 517-545, November.
    2. Golec, Joseph & Starks, Laura, 2004. "Performance fee contract change and mutual fund risk," Journal of Financial Economics, Elsevier, vol. 73(1), pages 93-118, July.
    3. Sanjiv Ranjan Das & Rangarajan K. Sundaram, 1998. "Fee Speech: Adverse Selection and the Regulation of Mutual Funds," NBER Working Papers 6644, National Bureau of Economic Research, Inc.
    4. Uday Rajan & Sanjay Srivastava, 2000. "Portfolio Delegation with Limited Liability," Econometric Society World Congress 2000 Contributed Papers 1503, Econometric Society.

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