How do performance-based fees work?

Performance-based fees, also known as incentive fees, are calculated as a percentage of the fund’s profits. For example, if a hedge fund has a performance fee of 30% and it generates a profit of $1 million, the fund manager would earn $300,000 as a performance fee. These fees align the interests of the fund manager with those of the investors, as the manager is incentivized to achieve strong performance.