What it means
Two providers can quote what sounds like the same price and cost dramatically different amounts. One might charge a flat monthly amount, another a percentage of volume with a minimum charge, and the customer's own usage pattern determines which is cheaper.
Common building blocks include a fixed periodic charge, a variable rate on volume or value, and tiered rates that fall as volume rises. Layered on top are minimum charges that protect the provider on small accounts, and event-based charges such as setup, exit or late payment fees.
Fee structures also encode incentives, deliberately or otherwise. A fund manager paid only on assets is rewarded for gathering money, while one paid partly on performance is rewarded for returns, and the second arrangement can encourage more risk-taking than the client intended.
Protective features exist to correct those incentives. A hurdle rate means no performance fee until returns exceed a stated threshold, and a high-water mark prevents a manager charging twice for recovering losses they previously caused.
For anyone reviewing a proposal, the practical technique is to model the structure against your own realistic volumes rather than the provider's illustration. Running last year's actual figures through each competing structure turns a marketing comparison into an arithmetic one.
In practice
Real-world examples.
Example
A payroll provider quotes $4 per payslip with a $250 monthly minimum. For a company running 40 payslips a month the minimum bites, making the real cost $6.25 per payslip rather than $4.
Example
A freight forwarder uses tiered pricing: $95 per pallet up to 50 pallets a month, then $78 above that. A retailer shipping 80 pallets pays 50 x $95 plus 30 x $78, which is $4,750 plus $2,340, or $7,090.
Example
An advertising agency moves from an hourly rate to a monthly retainer of $18,000 plus 3% of media spend. The client's costs become predictable on the creative side but rise automatically as campaigns scale.
Formula
Calculation
Total fees = management fee + performance fee, where the performance fee is a share of gains, usually calculated after the management fee has been deducted
Copperfield Growth Fund manages $100,000,000 on a fee structure of 2% a year on assets plus 20% of gains. In a year when the portfolio gains 15% before fees:
Management fee: 2% x $100,000,000 = $2,000,000
Gross gain: 15% x $100,000,000 = $15,000,000
Gain after the management fee: $15,000,000 - $2,000,000 = $13,000,000
Performance fee: 20% x $13,000,000 = $2,600,000
Total fees: $2,000,000 + $2,600,000 = $4,600,000
Investor's net gain: $15,000,000 - $4,600,000 = $10,400,000, a net return of $10,400,000 / $100,000,000 = 10.4%
The manager takes $4,600,000 of the $15,000,000 gross gain, close to a third of it. In a flat year with no gain at all, the investor would still pay the $2,000,000 management fee and would be down 2%, which is exactly why the structure, not the headline percentage, is the thing to negotiate.Case study
Seen in the real world.
This fictional, illustrative case concerns Halcyon Ventures, a family investment company reviewing three managers for a $40,000,000 mandate. Each quoted what looked like broadly similar terms.
Halcyon modelled all three structures against a 7% gross return. Manager A charged a flat 1.2% and cost $480,000. Manager B charged 0.6% plus 15% of gains above a 4% hurdle, costing $240,000 plus 15% of the $1,200,000 excess return, or $180,000, a total of $420,000. Manager C charged 0.5% plus 20% of all gains, costing $200,000 plus 20% of $2,800,000, which is $560,000, a total of $760,000.
The cheapest headline rate produced the most expensive outcome. Halcyon appointed Manager B, insisted on a high-water mark, and adopted a standing rule that no mandate would be awarded until the structure had been modelled at a poor return, an average return and a strong one.
Watch out
Common mistakes.
- Choosing a provider on the headline rate. Minimums, tiers, setup charges and exit penalties routinely change the ranking once real volumes are applied.
- Ignoring what the structure rewards. A charge based purely on assets or spend rewards growth in that base, which may not be the outcome the client is paying for.
- Overlooking exit costs when signing. Termination notice periods, unamortised setup charges and data extraction fees can make switching provider far more expensive than the annual saving.
Questions
People also ask.
What is a high-water mark?
A rule that a performance fee is only payable on gains above the highest value previously reached, so a manager cannot charge twice for recovering the same losses.
What is a hurdle rate in a fee structure?
A minimum return that must be achieved before any performance fee applies, ensuring the client receives a base level of return first.
How should I compare two fee structures fairly?
Model both against your own actual historic volumes and against a poor scenario as well as a good one, then compare total annual cost rather than rates.
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