Performance Based Compensation – Definition

Cite this article as:"Performance Based Compensation – Definition," in The Business Professor, updated September 14, 2019, last accessed May 27, 2020, https://thebusinessprofessor.com/lesson/performance-based-compensation-definition/.

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Performance-Based Compensation Definition

Performance-based compensation refers to a type of compensation that portfolio managers tend to receive. Mutual funds that are associated with performance-based compensation may charge a managerial fees of 0.2%. Talking about the investment sector, hedge fund experts get big amounts of performance-based compensation.

Breaking down Performance-based compensation

Performance-based compensation is a compensation driven by monetary incentives, and is used for making payments to portfolio managers. In the sector where hedging of funds takes place on a large scale, it is common to include an additional performance-based fees.

Investment company compensation

The Investment Company Act of 1940 regulates the mutual fund sector, and establishes specific rules and policies so as to set specific compensation criterion for portfolio managers. The board of directors of investment firms gives consent to the compensation criterion of portfolio managers. It is also necessary for firms to issue a registration statement such as prospectus along with a statement offering more information, and providing details on funds inclusive of compensation. As there is uniformity in the documentation policy and benchmarks of publicly traded funds, it makes it easier for investors to compare among different funds. Because of this consistency, mutual fund managers tend to charge a specific fee as portion of the total operating expenses of fund on a yearly basis.

The fees for managing mutual fund portfolio can vary from 0.5% to 2.5%. The active fund managers receive a bigger amount of compensation though. The management fees for portfolio usually includes the major chunk of gross annual operating costs of a mutual fund. Mutual fund managers are also offered an additional amount of performance-based fees. Such amount of fees is already provided in the registration document that is agreed upon by the company’s board of directors.

Fidelity, a mutual fund organization, provides performance-based compensation on its several funds. It has been using the approach of performance-based compensation since the year 1970. Around 67% of mutual funds that are invested and managed in equity are inclusive of performance-based compensation. However, the amount of compensation is quite less in comparison to hedge funds with the ability to generate an additional 0.20% to the managerial charges when a mutual fund performs as per the standards. On the other side, such fees can also be deducted when the fund doesn’t match the standards.

Hedge fund manager compensation

Hedge fund managers operating in the investment sector are widely recognized for their performance-based fees. As hedge funds have less regulations than conventional mutual funds, they tend to have a bigger scope of structuring fees schedule. Usually, hedge fund managers tend to charge a ‘two and twenty’ fee that calls for management fees that is more than mutual funds from the investors. The two and twenty hedge fund fee involves a flat fee of 2% followed by a performance fee of 20%. The 2% fees depends on the assets under management of mutual funds, while the 20% fee involves a performance-based compensation that is usually charged when the fund performs beyond the expectations, or the set standards. The hedge fund manager receives 20% fee from the profits secured by the fund.

References for “Performance-Based Compensation

https://www.investopedia.com › Investing › Mutual Funds

https://www.contractingbusiness.com/service/performance-based-compensation

www.masters-in-human-resources.org/faq/what-is-performance-based-pay/

https://bizfluent.com › Compensation

https://www.industryweek.com/compensation…/could-performance-based-pay-be-ans…

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