Fee structures direct investment management behavior and influence the KPIs of funds.
Fund managers cannot guarantee returns. But they will need to receive salary even in losing months. This causes stress between the manager and investor.
The effort to reduce fee may lead to a reduction in quality of talent and regulations. This can reduce performance and increase risk management capabilities.
Performance related fee structure that pays managers only if the fund makes money is risky. This structure may lead to managers taking extra risk to avoid losses, even if the strategy does not fit the fund objectives.
A more complex fee structure can lead to better risk management outcomes. For example, we may want the manager to reduce volatility instead of pursuing alpha.
The yardstick to measure performance in investment management is complex. Do we pay managers for high returns and risk deviating from the investment objective? Or do we pay managers for mirroring a specific beta type?
In short, do we pay for better management quality or for higher earnings? It takes better managers to stick to management objectives than to seek opportunistic investments.
This is why managers are subject to complex fee structures such as risk adjusted returns and clawback schemes.