What are "performance fees" in mutual funds?

Performance fees in mutual funds are structured as fees that are charged based on the investment performance of the fund. This means that the fee is calculated as a percentage of the fund’s profits, typically only when those profits exceed a certain benchmark or threshold. The purpose of performance fees is to align the interests of the fund managers with those of the investors; if the fund performs well and generates returns, both the investors and the managers benefit. This structure incentivizes fund managers to achieve the best possible returns.

The other options describe different types of fees that do not relate specifically to the performance of fund investments. For instance, fees based on the number of investors would not reflect investment success or fund profitability. Flat fees charged regardless of investment activity do not vary with performance and thus do not incentivize managers to improve returns. Finally, fees charged only during the initial investment contradict the ongoing nature of performance fees, which are contingent on the fund's continuing success and profitability over time.