Management Fee

A management fee is the amount an investment manager charges for managing a fund or a client's portfolio. It is usually set as a fixed annual percentage of the assets under management, for example 0.60% a year, and is deducted from the fund's assets in small daily or monthly amounts. It pays for the portfolio manager, research analysts, trading desk and the adviser's overheads and profit.

In a mutual fund or exchange-traded fund (ETF), the management fee is one part, usually the largest, of the fund's expense ratio. It should not be confused with the total expense ratio, with one-off sales charges, or with a performance fee, which rewards the manager only when returns pass a set level. Hedge funds and private equity funds typically charge both a management fee and a performance fee.

A management fee is like the yearly fee you might pay a property manager to look after a rental flat: a set percentage of the value they look after, paid whether the year turns out well or badly. The bigger the property, the bigger the fee in money terms, even though the percentage stays the same.

You never hand over cash directly. The fee is quietly taken from the fund itself, which makes your share a little smaller each day. That is why the percentage matters so much: a small number taken every year on everything you own adds up.

A simple asset-based fee works like this:

Here $\text{Average assets under management}$ is the average value of the money being managed during the year, and $\text{Fee rate}$ is the agreed annual percentage written as a decimal. A fund with average assets of $200 million and a fee rate of 0.50% pays its adviser $200{,}000{,}000 \times 0.005 = 1{,}000{,}000$ dollars for the year. Because the fee is a percentage of assets under management (AUM), the adviser earns more when markets rise or when new money flows in.

Many funds use breakpoints in the fee schedule, cutting the rate on assets above certain levels so that shareholders share in economies of scale. Some advisers agree to waive part of the fee for a period to keep a new fund's costs competitive.

The traditional hedge fund model, "2 and 20", combined a 2% management fee with a 20% share of profits, usually only above a "high-water mark" so the manager is not paid twice for recovering earlier losses. Industry studies show average hedge fund management fees have drifted below 2% since the 2008 crisis. Private equity and venture capital funds charge a management fee on committed capital plus "carried interest", a share of profits paid when investments are sold.

Under the Investment Company Act of 1940, a registered fund's advisory contract, including the fee, must be approved by the fund's board, with a majority of its independent members renewing it each year under Section 15(c). Section 36(b) makes the investment adviser a fiduciary with respect to the fees it receives and lets shareholders sue over excessive fees. In Jones v. Harris Associates (2010), the US Supreme Court held that a fee breaches this duty only if it is so disproportionately large that it bears no reasonable relationship to the services provided and could not have been the product of arm's-length bargaining.

The Investment Advisers Act of 1940 generally bars advisers from charging retail clients performance-based fees. Registered funds may use a "fulcrum fee", which rises and falls symmetrically around a benchmark, and wealthier "qualified clients" may agree to ordinary performance fees. In Europe, the European Securities and Markets Authority issued guidelines on performance fees in UCITS funds in 2020, and the Financial Conduct Authority (FCA) requires UK funds to disclose charges as an ongoing charges figure.

A management fee is certain while returns are not, so it directly lowers the investor's total return every year. An active manager must beat its benchmark by at least the fee to add value, which raises the bar for producing alpha. Low-fee index funds have grown rapidly for this reason. Investors can find the fee in the fund's prospectus fee table and on its fund fact sheet.

• Investor.gov (SEC): Management Fee
• Investor.gov (SEC): Mutual Fund and ETF Fees and Expenses