Poor Performance Puts Tamper on Contingent Fees

As the debate whether mutual funds should charge performance-based fees continues, Don Cassidy, a senior research analyst at Lipper, says the main reason such fees have not caught on is that more funds underperform than overperform benchmark indexes.

In his weekly radio address, Cassidy said that only 3% of funds with about 8% of total mutual fund assets, charge contingent fees, which are fees that are linked to a performance index. The idea is that when funds beat a certain index, these fees would go up by a certain percentage and would go down when funds lag an index. Companies such as Fidelity Investments and Vanguard Group have over 70 such funds, which together account for almost 90% of the assets, or about $500 million, that do charge contingent fees.

Although it sounds equitable in theory, most fund companies have not embraced contingent fees for a number of reasons. For instance, contingent fees would cause mutual funds to resemble hedge funds. They would also have to deal with the additional burden of calculating fees every day, thereby increasing their accounting costs.

Last but not least, in addition to making fees more volatile, if the contingent fees were to decline, they would send a red flag to investors that their portfolio manager is lagging the market.