Compensating Fund Managers for Risk–Adjusted Performance

Abstract

A risk-adjusted performance fee structure which addresses incentive compatibility and helps reduce asymmetry, while at the same time being feasible and easy to implement would be a practical performance fee structure that principally compensates the manager for risk-adjusted performance by adjusting for the volatility of returns. For a fund manager this can provide a credible way to offer a volatility target as well as a return target, since the manager's compensation is contingent on realized volatility. For risk-averse investors this opens up the opportunity to choose managers based on the manager's incentives to meet risk as well as return objectives.