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Funds and Performance Fees Don't Mesh


The mutual fund industry might be appeasing investors by cutting management fees, but it's yet to embrace the performance-based fees its loosely regulated counterpart, the hedge fund industry, has used to its advantage.

Charging performance fees, and cutting them in times of poor performance, is an uncommon practice in the mutual fund world, according to a Wall Street Journal report. Only 3% of mutual funds charge performance fees, and of those, which include Fidelity's Magellan and Vanguard's Windsor II, only 8% make up the roughly $8.1 trillion in assets in the industry, according to Lipper.

"I think they are a great idea. It's exactly pay-for-performance," said Kunal Kapoor, director of fund analysis at research firm Morningstar. He adds, however, "fund fees are already generous. I would not be a fan of adding performance fees to what we already have."

The problem with instituting performance fees in the case of mutual funds is that they need to pay hefty sums towards distribution, which come out of the management fees they charge. By replacing that with a less stable, returns-dependent performance fee, funds would jeopardize their ability to market themselves.

About a year ago, a hedge fund manager, Whitney Tilson decided to start a mutual fund company, for which he charged performance fees. Unlike a hedge fund, where investors typically lock their money for a year or a more, mutual fund investors can buy and sell out of funds every day. This means they're less likely to pay for long-term performance, which, in turn, means that it is more difficult to charge them a performance fee. That's exactly what Tilson discovered.

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