What’s the quickest way to goose the alpha of any fund – mutual or hedge?  Easy.  Slash fees.  Sure it hurts revenues, but it can also provide a desperately needed boost to alpha.

As we’ve discussed a few times on these pages, fees are quite literally the corollary to alpha.  Management fees amount to a charge against the alpha bottom line, if you will.  So, like cutting any expense on an income statement, the benefits of fee reductions accrue right to the bottom line.  Fees (like alpha) are uncorrelated and consistent sources of returns – in this case though, they’re negative returns.

Mutual funds are aware of this.  That’s how some of them manage to charge a stealth performance fee under the guise of benevolence (or at least fairness).  In a posting last winter, we told you about a family of Fidelity funds that offered a “fee adjustment to management fees”.  Essentially, Fidelity would charge a higher fee if the rolling 36 month performance beat a benchmark and would give back fees when performance stank (note: at least it’s symmetrical).

The effect of this is strategy, aside from adding volatility to the fund manager’s revenue stream, is to dampen volatility of the fund itself – particularly its alpha.  It’s the fund management equivalent of earnings management by CEOs.

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