What is a 'Performance Fee'

A performance fee is a payment made to a fund manager for generating positive returns. The performance fee is generally calculated as a percentage of investment profits, often both realized and unrealized. It is largely a feature of the hedge fund industry, where performance fees have made many hedge fund managers among the wealthiest people in the world.

BREAKING DOWN 'Performance Fee'

The basic rationale for performance fees is that they align the interests of fund managers and their investors, and are an incentive for fund managers to generate positive returns. A "2 and 20" annual fee structure - a management fee of 2% of the fund's net asset value and a performance fee of 20% of the fund's profits - has become standard practice among hedge funds. Critics of performance fees, including Warren Buffett, opine that the skewed structure of performance fees - where managers share in the funds' profits but not in their losses - only tempts fund managers to take inordinate risks to generate high returns.

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