Performance fees for mutual funds would encourage excessive risk taking. Performance fees can disproportionately favor mutual fund investment advisers over fund shareholders by giving advisers a monetary incentive to take investment risks in order to increase advisory fees. Under this type of arrangement, the adviser can be rewarded handsomely for good performance, with little or no penalty for poor performance. The lack of tradeoff may encourage some advisers to pursue high risk investment policies for higher returns and greater fees, without risk of financial loss if the strategy proves unsuccessful. While the danger of excessive risk taking under performance fee arrangements is hard to quantify, there is the risk that some advisers would mismanage the arrangement and cause unexpected losses to mutual fund investors.
Performance fees are appropriate, if at all, where the adviser has substantial capital at risk.
If the adviser has no capital at risk, there is less of a justification for one-way performance fees. Many mutual fund investors are not financially sophisticated or in a position to protect themselves from overreaching. A fundamental concern is the fairness of performance fees to investors. The adviser has everything to gain and little if anything to lose, while the investor has little to gain and everything to lose. Encouraging such one-way fee arrangements for registered investment companies, which offer shares to small and often unsophisticated investors, is not appropriate, particularly at a time when the industry is already criticized for excessive fees.