Carrot and Stick : A Risk-Sharing Rationale for Fulcrum Fees in Active Fund Management

We show that risk-sharing considerations rationalize symmetric benchmark-adjusted ("fulcrum") fees in the compensation of informed active fund management. By tying fees symmetrically to the appropriate benchmark, investors can tilt a fund portfolio toward their optimal risk exposure and realize nearly all the value of managers' information, at no extra cost of compensating managers for exposure to relative-performance risk. Under certain conditions, fulcrum fees are necessary to prevent passive alternatives from dominating active management. Our results can shed light on a recent debate on the appropriate fee structure of active funds in contexts of high competition from passive funds