What are performance fees?

Performance fees are specific charges levied by fund managers that directly relate to the investment performance of a fund. These fees serve as an incentive for fund managers to deliver superior returns, aligning their interests with those of the investors. Typically, the fee is calculated as a percentage of the profits generated by the fund above a predefined benchmark or hurdle rate. This means that if the fund performs well and exceeds expectations, the fund manager earns additional compensation, which can motivate them to strive for better investment outcomes.

The concept behind performance fees is rooted in a pay-for-performance structure, which is designed to reward fund managers for their effective management and successful investment strategies. This can lead to enhanced focus on generating returns, as their compensation is tied to the fund's success relative to its performance targets.