Fee Structure

A fee structure is a chart or list highlighting the rates on various business services or activities. A fee structure lets customers or clients know what to expect when working with a particular business. Potential customers should always examine a company's fee structure to make sure they find it satisfactory before deciding to do business with them.

Fee structures go a long way in determining the value of various services. When faced with many options, clients or customers can select from a range of service and benefits levels based on different fee structures (arrangements).

The fee structure for an online auction website, for example, would list the cost to place an item for sale, the website's commission if the item is sold, the cost to display the item more prominently in the site's search results and so on.

As another example, hedge fund's fee structure would show what the fund manager charges to run the fund, how much the fund manager will receive if the fund meets or exceeds predefined performance targets, and how much an investor must pay if he withdraws his funds prematurely. The classic fee structure for hedge funds is "2 and 20." Meaning, a fund manager charges 2% on assets under management and another 20% for profits or outperformance over some threshold. This fee structure would be used to provide a base level of fees for the management of the fund (2%), plus an additional 'incentive' fee aligning the manager and investor interest.

As the hedge fund fee structure shows, incentives often play a central role in selecting an appropriate fee structure.

For absolute return strategies, which seek to outperform regardless of market direction, incentive fees are often used. Relative performance strategies seek to outperform a benchmark; flat fee structures are more common.

Under a flat fee structure, asset managers often charge a simple, flat rate for assets under management. For instance, an institutional investment manager might charge a pension fund 1.25% for every dollar under management. As investment objectives and mandates become more tailored or sophisticated, fees generally increase as well.

In reality, in the management of another's capital, no fee structure is perfect. Fee structures with an incentive or outperformance component could encourage a "swing for the fences" mentality. Because a manager enjoys a disproportionate upside. While flat fees could stifle innovation, creativity, or drive since a fee is earned regardless of performance.