Anatomy of performance fees in Finnish mutual funds

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School of Business | Master's thesis
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OBJECTIVES OF THE STUDY: In this thesis, I study the use of performance fees in Finnish mutual funds, their impact on the funds' risk-adjusted return, risk and their theoretical value. Furthermore, utilizing simulation-based methods, my objective is to calculate a theoretical value for the performance fee structures in Finnish mutual funds. Finally, I also study the different regulatory approaches to performance fees in select European countries and the disclosure of Finnish funds' performance fees. DATA AND METHODOLOGY: My sample consists of 332 mutual funds registered in Finland and contains quarterly observations on each fund from March 2007 to December 2012. 40 of these funds utilize performance fees. The sample is free from survivorship bias. My analysis is primarily based on random effects panel regressions with a variety of risk and return variables as dependent variables and funds' individual characteristics as explanatory variables. I also utilize Monte Carlo simulation and the Margrabe model to calculate the cost of the fee for each of the funds in the sample. FINDINGS OF THE STUDY: Funds with performance fees offer better risk-adjusted returns. The introduction of a performance fee increases the funds' ex post four-factor alpha by on average 83 basis points per quarter. The results hold also when using Sharpe ratio and the raw quarterly return as dependent variables. The use of performance fees does not increase funds' volatility levels relative to funds without such fees. However, funds with performance fees exhibit higher tracking errors, implying that funds take more active risk compared to their counterparts. The theoretical value of the performance fee is on average 1.35% Furthermore, funds with performance fees, on average, offer significantly lower management and redemption fees than funds without such fee structures. The difference is 22 and 24 basis points p.a. for management and redemption fees, respectively. However, the extra cost associated with the performance fees makes these funds more expensive on an annual basis.
performance fee, incentive fee, risk-adjusted return, incentives, mutual funds, fund, management, principal-agent problem, simulation, spread option, principal-agent problem
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