The Securities and Exchange Commission proposed a rule Wednesday that would let registered fund managers charge performance-based fees, potentially bringing hedge-fund-style compensation into the 401(k) plans of roughly 70 million American workers.
The proposal, advanced under the commission leadership installed by President Donald Trump, would let mutual funds and ETFs charge higher fees when they beat a benchmark and lower fees when they lag it. Regulators argue the structure would better align manager pay with investor returns. Consumer advocates say the opposite: it invites higher costs and riskier bets inside retirement accounts where savers have little ability to negotiate terms.
Under current rules, most mutual funds charge a fixed percentage of assets under management regardless of results. A fund with a 1% expense ratio collects that 1% whether it beats the S&P 500 or trails it by 10 percentage points. Performance fees, common in hedge funds, typically run 15% to 20% of profits on top of a base management fee.
The SEC's proposal follows years of lobbying by parts of the asset management industry, which argues that flat fees reward asset gathering over investment skill. The commission approved the draft on a party-line vote, with the Republican majority in favor and the Democratic commissioners opposing. The proposal now enters a public comment period, typically 60 to 90 days, before the commission can vote on a final version.
The practical danger for retirement savers is that performance fees are notoriously difficult to compare across funds. Two funds can report the same headline expense ratio while one quietly collects an extra cut of gains. That opacity matters in 401(k) plans, where employers pick the menu of funds and workers generally choose from a short list with limited information beyond a summary prospectus.
Performance fees also create an incentive to swing for the fences. A manager who is paid only when returns exceed a benchmark has reason to take concentrated positions and chase volatile stocks, because a bad year costs the manager little while a good year pays handsomely. Economists call this an asymmetric payoff: the manager keeps the upside from luck and the investor absorbs the downside.
Several academic studies of hedge fund compensation have found that performance fees correlate with greater return volatility rather than higher net returns for investors. A 2015 study in the Journal of Financial Economics found that hedge funds with the highest incentive fees underperformed those with lower fees after accounting for risk.
The SEC has not yet published the full text of the proposal or the specific fee caps it would impose. The commission said the rule would include disclosure requirements intended to let investors compare performance-fee funds against flat-fee alternatives, though it did not detail the format. Public comments can be submitted through the SEC's website once the proposal is published in the Federal Register.
