What Is a Management Fee?
A management fee is a charge levied by an investment manager for overseeing an investment fund. The fee is intended to compensate managers for their time and expertise in selecting stocks and managing the portfolio. It can also include other charges such as investor relations(IR)expenses and the administration costs of the fund.
Key Takeaways
- Management fees are the cost of having an investment fund professionally managed by an investment manager.
- The management fees may or may not cover not only the cost of paying the managers but also the costs of investor relations and any administrative costs.
- Fee structures are usually based on a percentage of assets under management (AUM).
- Fees tend to range from 0.10% tomore than 2% of AUM.
How Management Fees Work
A management fee is the cost of having your assets professionally handled. The fee compensates professional money managers as they select securities for a fund’s portfolio and manage it based on the fund’s investment objective.
Management fee structures vary from fund to fund but they're typically based on a percentage of assets under management (AUM).
A mutual fund's management fee could be stated as 0.5% of assets under management.
Wide Disparity in Management Fees
Management fees can range from as low as 0.10% to more than 2% of AUM. This disparity in the fee is generally attributed to the investment method used by the fund’s manager. The more actively managed a fund is, the higher the management fees.
An aggressive stock fund that turns over its portfolio several times a year in search of profit opportunities costs much more to manage than a more passively-managed fund, such as an index fund thatmore or lesssits on a basket of stocks without much trading.
Actively-managed funds generally result in higher management fees than those that are more passively managed but they don't necessarily see better returns than those of passively-managed funds. They might see worse returns in some cases.
Are High Management Fees Worth the Cost?
Active fund managers rely on inefficiencies and mispricing in the market to identify stocks that have the potential to outperform the market. The efficient market hypothesis (EMH) has shown that stock prices fully reflect all available information and expectations, however, so current prices are the best approximation of a company’s intrinsic value.
This would preclude anyone from consistently exploiting mispriced stocks because price movements are largely random and driven by unforeseen events. The EMH therefore implies that no active investor can consistently beat the market over long periods except by chance. Higher-cost actively-managed funds do tend to underperform lower-cost passively-managed funds in all categories, according to decades of Morningstar research.
Research by Nobel laureate William Sharpe has shown that “After costs, the return on the average actively-managed dollar will be less than the return on the average passively-managed dollar for any time period.”
Sharpe concluded that active fund managers underperform passive fund managers not because of any flaw in their strategies but because of the laws of arithmetic. Active fund managers would have to achieve an excess return of more than 2% just to account for the average 1.19% management fee to beat the market by only 1%.
Hedge Fund Management Fees
Hedge funds charge notoriously high fees that have become controversial as performance has often lagged the market. Their fee structure is commonly referred to as "twoand twenty" because it consists of a flat 2% of total asset value and 20% of all profits earned.
The plan is often criticized but it's been the norm since Alfred Winslow Jones founded what is often considered to be the first hedge fund, AW Jones & Co., in 1949. The standard has come under pressure as competition has increased and investors have become discontent, causing managers to often implement lower fees, performance hurdles, and claw-backs if performance isn't met.
What Fees May Be Payable in Addition to Management Fees?
The U.S. Securities and Exchange Commission cites penalty fees for not maintaining a minimum balance in your account. You might also have to pay inactivity fees and various additional maintenance fees.
What Are 12b-1 Fees?
These fees are commonly charged to mutual funds. They cover the costs of marketing and shareholder services and they can even pay for employee bonuses. The good news is that they usually can't be more than 1% of the assets you hold.
Do 401(k) Plans Have Fees?
They do and they're commonly paid by the plan's participants. The Plan Sponsor Council of America estimates that they amount to about $30 billion annually, but you can take a little heart because this number is spread over 60 million participants holding $3 trillion in assets.
ERISA, the Employee Retirement Income Securities Act, oversees 401(k) plans but it has authority only over plan sponsors, not their investment managers.
The Bottom Line
Fees and costs are common with all investment products, at least to some degree, and they can vary significantly among types of investments and brokerages. Your best bet is to inquire about them and pin down what and how much you'll be responsible for paying before you commit. It can pay to shop around.
