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INCENTIVE FEES AND MUTUAL FUNDS

Though still small – a market for green investments is also starting to grow. Alongside more developed equity products (such as green indices comprising of listed companies operating in the green space), fixed income instruments are also being launched – notably green bonds, for which the OECD estimates that the market is now around USD 16 billion. Alongside the World Bank‟s USD 2.3 billion issuance, other development banks have become involved (EIB, ADB) and the US government has introduced interesting initiatives. Other more exotic green financial vehicles have also been. | INCENTIVE FEES AND MUTUAL FUNDS Edwin J. Elton Martin J. Gruber Christopher R. Blake March 28 2002 Nomora Professors of Finance New York University Associate Professor of Finance Fordham University The authors would like to thank Salomon Center- Institute of Finance at New York University and the BSI Gamma Foundation for financial support. We also thank Lipper Inc. and in particular Jeffrey C. Keil for supplying incentive fee and fund data. In addition we would like to thank Deepak Agrawal Gordon Alexander and participants in the 2001 meeting of the European Finance Association Barcelona for helpful comments. An incentive fee is a reward structure that makes management compensation a function of investment performance relative to some benchmark. Incentive fees are often used to compensate the manager of investment assets. For example hedge funds typically charge investors a fixed fee plus an incentive fee equal to between 5 and 25 of the fund s annual return. Limited liability partnerships such as commodity partnerships real estate partnerships and oil and gas partnerships often charge incentive fees in excess of 20 of profits. There are a number of reasons why incentive fees are considered desirable. Perhaps the most often cited is that incentive fees align manager interest with investor interests. Both groups do better when the investment does better. Thus the argument goes management effort should be higher for funds with incentive fees. Closely associated with this is the argument that the best managers will gravitate towards investment pools that have incentive fees since they can make more money by managing such pools. The argument continues that since investors realize that funds with incentive fees draw the best managers and elicit the most effort the investors are willing to place more money in these funds.1 While financial economists can and have theorized about the impact of incentive fees there has been very little empirical analysis of the impact of .