The Truth About Performance Fees

With the introduction of new fee types into TokenSets social sets it introduced a number of new cost dynamics for buyers. From those new dynamics comes a number of questions: What fees types benefit me (the buyer) the most? What fee percentage is the most appropriate? Is there any difference between the fee types or will they all ultimately end up costing me about the same? And many more questions…

These types of questions are right up my alley as I have spent my entire trading career teaching other traders how to perform various cost/benefit analysis. Fees that buyers pay are really no different as they too have their own cost/benefit structures with certain fee models benefiting the trader more than the buyer in certain scenarios and vice-versa. My goal here is to offer data for you to critically think about fees and their implications.

The study

For this article I wanted to focus primarily on the performance fee and how it compares to the other 2 fee types: the streaming fee(similar to a management fee) and the entry fee. I am going to categorize the fees based on 1 simple criteria… who will the fee cost the most in the bulk of trading scenarios.

Below I present you the models that were ran to test the cost/benefit of various trading outcomes with various fee models. I created 4 trading outcomes: large win with no loss, large with with large loss, moderate win with a small loss, and no win with a moderate loss. While these 4 outcomes are far from comprehensive I feel they at least cover a general range of trading outcomes that traders could face in a given year. I created 3 fee models: Performance Only, Management Only and Mixed fee models. I wanted to use real dollars and cents that everyone could relate to so every scenario starts with a 1 million dollar set balance. I then show the end-of-year traders profit, buyers profit, and the the net difference(traders profit minus buyer profit).

Above you can see that in 2 out of the 4 scenarios the 3% management only fee is the least costly for the buyer. In 1 of the 4 the mixed model (2% management and 5% performance fees) is the least costly. In 1 of the 4 models the performance fee is the least costly for the trader. Even though this shows that a management fee is least costly to the buyer in most situations, there is actually more to the story. What about looking at how costly each one is.

When looking at how much of the sets entire market cap that the trader pockets we can see that the performance fee is vastly higher. As a matter of fact in the “large win/large loss scenario” the trader pockets a $100,000 fee payout, while their buyers lose $100,000. It’s hard to argue that a performance-only fee is the most beneficial fee model for the buyer when scenario’s like these can play out.

Some buyers consider performance fees as a type of “insurance” because they only pay the fee when they profit. First, our models show that isn’t entirely true, a buyer can indeed pay out the high performance fee and still take large losses. Second, we can see that the performance fee cost can be as high as 400% higher than the other fees during the same trading scenario. At some point the premium of the performance fee over the other fee types outweigh any perceived benefits.

The Conclusion

My goal here is to not convince you that fees should be risk-free, because they shouldn’t be, but to cause you to critically think about what fee models are most economical for you. The biggest takeaways from this are 1) there is no single fee type that is best for the buyer in every situation but that 2) either a management only or mixed performance saves the buyer the most in fees in the widest range of scenarios and 3) an appropriately sized mix of performance and streaming fee likely have the best balance of being both trader and buyer focused.

I also want to touch on an argument I hear from buyers which is that the performance fee is a great way to reward the trader and encourage them to perform better. My response is that a trader should be bringing their best performance every day no matter what fee structure they have. That is our obligation as traders to our buyers. Don’t worry about the trader maximizing their fee profits. It’s the traders job to figure out how to have competitive fees and still turn a profit to make it worth their while.

Final Comments

I will wrap up this article by reminding everyone that performance fees are not a risk-free structure. In fact the data shows that in most scenarios they can be more costly than other fee types. I want to urge buyers to critically think about the fees they are paying and to focus on both set performance(i.e. % gains, drawdown, etc.) and also the cost of fees. Both have a large impact on how much you will make (and keep) in the long term.

Additional Resources

Why Performance And Fulcrum Fees Are Banned For Most Financial Advisors
Don’t Fall For Performance Based Fees

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