India’s Securities and Exchange Board of India (SEBI) has launched a performance-based fee model for mutual funds. This model moves away from the traditional total expense ratio (TER) structure. It allows fund houses to link their fees directly to a fund’s performance. This change could transform revenue models across the industry. However, many fund houses are still hesitant to adopt this new approach.

SEBI discussed the new performance-linked fee model at the Moneycontrol Mutual Fund Summit on June 30, 2026. SEBI Executive Director Manoj Kumar noted that the regulatory body has set up the framework. However, there has been little enthusiasm from the industry to embrace it. This hesitance raises questions about operational challenges and complexities related to the new fee structure. Kumar mentioned that the industry’s cautious stance partly stems from fears of misalignment between performance metrics and investor expectations.

Understanding the Performance-Linked Fee Model

The performance-linked fee model allows mutual funds to charge fees based on their performance. This is different from charging a fixed percentage of assets under management. The model includes a hurdle rate, a high-water mark, and a catch-up provision. The hurdle rate is the minimum return a fund must achieve before charging performance fees. The high-water mark prevents fund managers from charging fees on the same gains multiple times. The catch-up provision allows managers to earn fees on full returns after surpassing the hurdle rate.

For example, if a mutual fund has a hurdle rate of 10% and achieves a 19% return, the performance fee applies only to the 9% exceeding the hurdle. This structure aligns the interests of fund managers with those of investors. It encourages a focus on long-term performance rather than just increasing assets under management. This alignment is crucial for creating a sustainable investment environment where fund managers generate real value for their clients.

Shweta Rajani, Head of Mutual Funds at Anand Rathi Wealth, believes this model could motivate fund houses to prioritize consistent long-term performance. However, the complexity of this fee structure may pose challenges for both fund managers and investors. Nitin Agrawal, CEO of Mutual Funds by InCred Money, emphasized that while the model aims to reward genuine performance, it could confuse investors about costs and fee assessments. This potential miscommunication could deter less financially literate investors from engaging with funds using this new structure.

Smaller fund houses may struggle to invest in the sophisticated tracking and reporting systems needed to manage these fees effectively.

Despite the potential benefits, many fund houses remain cautious about the new model. Operational challenges, such as fairly calculating performance-linked fees, have deterred some firms. Rajani pointed out that different investors entering the same fund at various times could face different outcomes. This variability complicates the fee calculation process and could lead to dissatisfaction among investors.

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Industry Hesitance and Operational Challenges

One main reason for the hesitance among fund houses is the complexity of implementing the performance-linked fee model. Rajani highlighted that calculating appropriate fees can be challenging, especially with constant investor inflows and outflows. This complexity can create varying experiences for investors who join the same fund at different times. Smaller fund houses may struggle to invest in the sophisticated tracking and reporting systems needed to manage these fees effectively.

Additionally, the Indian mutual fund industry is mostly distributor-led. A predictable fee structure is easier to sell. A flat TER is simpler for distributors to explain to potential investors than a variable fee structure based on performance. Agrawal noted that the current system’s simplicity makes it more appealing in a competitive market. This reliance on traditional fee structures may hinder innovation, as distributors and investors may prefer familiar models.

Moreover, there are concerns that the performance-linked model may encourage excessive risk-taking by fund managers. If not carefully designed, the model could lead to short-term strategies that do not align with investors’ long-term interests. Rajani warned that this shift could result in investors paying higher fees even when their overall investment experience is less favorable. This potential misalignment highlights the need for strong regulatory safeguards to ensure that performance metrics reflect genuine value creation.

Despite these challenges, discussions continue within the industry about effectively implementing performance-linked fees. Experts emphasize that any performance fee should relate to benchmark-relative performance, not just absolute returns. Assessments should occur over rolling multi-year periods. This approach would ensure fees reflect genuine performance rather than short-term market fluctuations. As noted in a recent Mint article, the industry’s cautious approach may stem from a desire to avoid pitfalls associated with poorly designed performance metrics that could harm investor trust.

As the mutual fund industry considers the shift to performance-linked fees, several factors will determine its success.

As the mutual fund industry considers the shift to performance-linked fees, several factors will determine its success. The regulatory framework established by SEBI provides a foundation for this transition. However, the industry’s willingness to adapt will be crucial. If fund houses can overcome operational challenges and embrace the new model, it could lead to a more competitive landscape focused on delivering value to investors.

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Furthermore, as investors become more informed and demand transparency, pressure on fund managers to adopt performance-based structures may increase. Investors are looking for alignment between their interests and those of fund managers. A well-implemented performance-linked fee model could meet this demand and foster a culture of accountability within the industry. As highlighted by Economic Times, the potential benefits of this model could enhance investor confidence and lead to greater participation in the mutual fund sector.

In the coming months, it will be essential to monitor how fund houses respond to SEBI’s framework. Will they embrace the chance to innovate their fee structures, or will they stick with traditional TER models? The answer to this question could significantly impact the mutual fund landscape in India.

As this transformation unfolds, mutual fund managers must stay vigilant and adaptable. The evolving regulatory environment and changing investor preferences will shape the future of fee structures in the industry. A more performance-oriented approach could redefine how mutual funds operate, but only if the industry is willing to embrace change.

Frequently Asked Questions

What are the benefits of performance-linked fees for mutual fund managers?

Performance-linked fees can motivate mutual fund managers to focus on generating consistent long-term returns. This alignment of interests could lead to better performance and potentially higher revenues for managers who excel in delivering value to investors.

Mutual fund managers should assess their operational capabilities to implement the new fee structure effectively.

How can investment advisors adjust to SEBI’s new fee model?

Investment advisors can adapt by educating clients about the benefits of performance-linked fees. They should also stay informed about the evolving regulatory landscape to provide relevant advice to their clients.

What should mutual fund managers do to prepare for the shift to performance-linked fees?

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Mutual fund managers should assess their operational capabilities to implement the new fee structure effectively. They may also consider developing strategies that emphasize long-term performance to align with the new model and meet investor expectations.