What is a 'Fulcrum Fee'

A fulcrum fee is a performance-based fee that adjusts up or down based on outperforming or underperforming a benchmark. Fulcrum fees can be charged by a financial adviser or an asset manager to qualified clients to link outperformance (or lack thereof) to compensation.

Breaking Down 'Fulcrum Fee'

A fulcrum fee is the only performance-based fee that financial advisers are permitted to charge clients. The Investment Advisers Act of 1940 first prohibited performance-based fees, as they give advisers too much incentive to take undue risks with their client money. It wasn't until 1970 that congress permitted performance-based fees, such as a fulcrum fee — but only by Registered Investment Advisers (RIA) serving as investment managers to mutual funds. It wasn't until 1985 that the Securities and Exchange Commission further allowed advisers to use fulcrum fees with retail clients, and only because the adviser participates equally in the downside and the upside of an investment. A couple of conditions must be met in order for an adviser to charge a fulcrum fee:

1) The returns must exceed the appropriate benchmark (and if they don't, the base fee must be reduced).
2) The only clients that can be charged this way are: individuals or registered investment companies with an account value greater than $1 million or a net worth greater than $2.1 million. Such clients are known as "qualified clients," defined under Rule 205-3 of the Investment Advisors Act of 1940.

Fulcrum Fees: Recent Developments

In 2016, fulcrum fees accounted for less than 2% of U.S. registered funds (194 funds; $790 billion). Fulcrum fee use is expected to increase as pressure builds on asset managers to either lower fees on actively managed funds or justify them with better performance. Fulcrum fees are already in use in exchange-traded funds.

In late 2017, Fidelity International announced that it would overhaul its equity fee strategy to a fulcrum fee model. In effect, it would offer a new share class for 10 active equity funds that would carry a management charge that was 10 basis points lower than current prices. Depending on the performance of the funds, that fee would either rise or fall by 20 basis points (performance would be measured on a three-year rolling basis).

The reason why a fund management giant would employ a fulcrum fee on actively managed funds is because they continue to underperform lower-cost index (passive) funds, which have captured the lion's share of net inflows in the U.S. over the last decade. To make active equity funds more popular, Fidelity is essentially lowering their cost but allowing themselves to participate on the upside if they beat their bogey.

Fidelity is not alone in selectively using fulcrum fees; Vanguard, Janus and Alliance Bernstein, as well as other fund managers, also employ them.

Fulcrum Fees: Do They Work?

According to research, incentive fees for mutual funds have not shown any association with improved risk-adjusted performance. Rather, mutual funds managers paid via incentive fees tend to achieve higher returns simply by taking on more risk. Worse yet, when then lag their benchmarks they add more risk. Despite this, such performance-based fees remain popular with investors.

  1. Service Shares

    Service shares are shares of a mutual fund that charge an extra ...
  2. Fee Structure

    A fee structure describes how an entity is to be compensated ...
  3. Brokerage Fee

    A brokerage fee is fee charged by a broker to execute transactions ...
  4. SEC Fee

    The SEC fee is a transaction cost attached to the selling of ...
  5. Bank Fees

    Bank fees are nominal fees for a variety of account set-up and ...
  6. Investment Manager

    An investment manager is a person or organization that makes ...
Related Articles
  1. Investing

    3 Investment Fees That Are Negotiable

    Investment fees are a necessary evil but that doesn't mean they have to be overly costly. There are ways to negotiate some of the expenses down.
  2. Investing

    Understanding Investment Fees Is Critical to Success

    Awareness of the different layers of investment fees can help you, as an investor, reduce the fees you're paying and increase your investments.
  3. Financial Advisor

    How Mutual Fund Companies Make Money

    Read about the many different kinds of fees and sales charges mutual fund companies can use to generate revenue from those who invest in their shares.
  4. Investing

    12b-1: Understanding Mutual Fund Fees

    Many mutual funds charge investors a 12b-1 fee to pay for marketing and promotion expenses.
  5. Investing

    Mutual funds: Management fees versus MER

    Having a clear understanding of the fees charged by a mutual fund is a significant component to making an informed investment decision.
  6. Investing

    Investors: Your Fees Are Probably Too High

    The lower your fees, the higher your returns. Here's how to find out if you're paying too much for your investments.
  7. Financial Advisor

    How to Know if Your 401(k) Plan Fees Are Too High

    Finding out how much you are paying for your 401(k) plan takes some research, but you should know exactly what you are getting for your money.
  8. Investing

    Fidelity Investments to Overhaul Fees It Charges Customers

    Aiming to simplify the fees it charges customers, Fidelity Investments is overhauling its pricing structure.
  9. Personal Finance

    Watch Out for "Junk" Mortgage Fees

    So many fees are tacked onto a mortgage, that it's easy to pay more than you have to.
  1. What kinds of fees are involved in futures trading?

    Learn what the various costs are that are charged by brokerage firms and trading exchanges to individual futures trading ... Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center