* When should fulcrum fees (1) be preferred over flat fees or other performance fee structures?
(1.) Fulcrum fees are centered on a base fee that is adjusted up or down based on performance relative to a clearly defined benchmark.
Performance fees may be either symmetrical (fulcrum fees) or asymmetrical (bonus plan).
Since then, only a handful of US managers have been brave enough to adopt fulcrum fees. Almost everyone opted for a reward scheme based on management fees only, depriving researchers of the data needed for a meaningful empirical investigation into the compensation structure of mutual fund managers agreed upon by investors in a free contracting environment.
We also find that in a free contracting environment, there is an overwhelming preference for some form of bonus plan over fulcrum fees. The latter never occurs in our sample, casting serious doubts over the signaling function sometimes assigned to performance fee provisions.
Even though managers remain exposed to some downside risk, the fear that asymmetrical incentive fees still provide them with an inappropriate incentive for tilting their investment strategies toward excessive risk prompted the US Congress to forbid bonus plans and to allow only fulcrum fees. A variety of bonus plans spring from the structure shown in Equation (1).
The policy provides specific guidance to investment managers and staff regarding the preferred structure of fulcrum fees (fees centered on a target, or "fulcrum," performance level, which are increased or decreased for better or worse performance) and performance fees (additional, performance-based fees paid when an investment manager achieves an investment return that beats a specified benchmark).
For the performance fee, managers of traditional asset classes often design a fulcrum fee that centers on the expected return, which is preferably an "alpha" return over the benchmark for that strategy--for instance, "benchmark plus 200 basis points." The total fee at that level of performance would then equal the competitive fixed fee, in a symmetrical structure that also includes a fee cap that is equidistant from the fulcrum point to the base and the ceiling.