Performance-Linked Fees in Mutual Funds: How the New Fee Structure Works
Blog by Aliceblue News Desk
20 October 2026
12 minutes
Mutual fund investors are familiar with one basic rule: whether a fund performs well or poorly, the asset management company still charges an expense ratio.
SEBI’s new mutual fund regulatory framework opens the door to changing that.
Under the SEBI (Mutual Funds) Regulations, 2026, asset management companies can potentially adopt a performance-linked fee structure, where part of the fee charged by a mutual fund is connected to how the scheme performs against a specified benchmark.
The idea is relatively simple: if a fund manager generates better performance, the AMC may be able to earn a higher fee. If the fund underperforms, the fee should correspondingly reduce under a symmetric performance-linked structure.
This could create better alignment between investors and fund managers. However, performance-linked fees also introduce new questions around benchmarking, calculations, risk-taking and transparency.
So, how do performance-linked fees in mutual funds work, and what could they mean for investors?
What Are Performance-Linked Fees in Mutual Funds?
A performance-linked fee is a fee structure under which the amount charged by an asset management company can depend partly on the investment performance of the mutual fund scheme.
Traditionally, mutual funds charge investors through an expense ratio calculated as a percentage of the scheme’s assets.
That means the AMC earns management fees regardless of whether the fund:
- beats its benchmark,
- matches its benchmark, or
- underperforms its benchmark.
Performance-linked fees introduce a different approach.
Instead of compensation depending entirely on assets under management, a part of the fee may be linked to whether the fund manager actually delivers performance against an appropriate benchmark.
For investors who want to understand how existing fund expenses affect returns, read Alice Blue’s guide on What Is Expense Ratio in Mutual Funds and Why Does It Matter?
Why Has SEBI Introduced Performance-Linked Fees?
The basic objective is to improve the alignment between the interests of mutual fund investors and asset management companies.
Consider an actively managed equity fund.
Suppose its benchmark produces a return of 12%, while the mutual fund produces only 8%.
Under a conventional fee structure, the AMC can still charge its normal management expenses, subject to regulatory limits.
Now consider another fund that produces 16% while its benchmark gains 12%.
Both funds may charge fees under the conventional expense structure even though their relative performance is very different.
A performance-linked model attempts to address this difference by connecting at least part of the AMC’s compensation with investment outcomes.
SEBI’s 2026 framework therefore provides an enabling mechanism for performance-linked fees rather than requiring every mutual fund to use them.
How Do Performance-Linked Mutual Fund Fees Work?
The framework can broadly be understood through two components.
1. Base Fee
The fund may continue to have a base expense component that covers investment management and other permitted operating expenses.
SEBI’s wider 2026 expense reforms introduced the concept of a Base Expense Ratio or BER.
Under the new structure, the Total Expense Ratio can broadly consist of the Base Expense Ratio along with permitted brokerage, transaction costs and statutory or regulatory levies.
SEBI has also revised the permitted BER limits for different types and sizes of mutual fund schemes.
2. Performance-Linked Component
On top of the basic fee framework, an eligible scheme adopting the performance-linked model may link part of its fees to performance against a predetermined benchmark and prescribed conditions.
In simple terms:
Better relative performance → potentially higher fee
Weaker relative performance → lower fee or adjustment
Importantly, SEBI’s framework is intended to be symmetric. A performance structure should not simply reward the AMC when the fund performs well while allowing it to keep the same fee when performance disappoints.
Detailed calculation methods, eligible schemes, benchmark requirements and other operational conditions are subject to SEBI’s applicable rules and disclosures.
Performance-Linked Fees vs Traditional Expense Ratio
Here is a simplified comparison:
Factor | Traditional Fee Model | Performance-Linked Model |
Main basis of fee | Assets managed | Base expenses + performance component |
Fee changes with performance | Generally no | Potentially yes |
Benchmark relevance | Mainly used to measure performance | Can influence fee calculation |
AMC rewarded for outperformance | Not directly | Potentially |
AMC fee affected by underperformance | Usually not directly | Can be |
Complexity | Relatively simple | Higher |
Investor-AMC alignment | Limited | Potentially stronger |
The biggest difference is therefore not simply the level of fees.
It is what determines those fees.
Example of How Performance-Linked Fees Could Work
Suppose a hypothetical actively managed equity mutual fund uses the Nifty 500 as its benchmark.
Assume:
- Benchmark return: 10%
- Mutual fund return before applicable expenses: 13%
- Relative outperformance: 3%
Under a performance-linked arrangement, the scheme’s fee methodology could allow an additional performance component when the fund satisfies the prescribed outperformance conditions.
Now consider another period:
- Benchmark return: 10%
- Mutual fund return: 7%
- Relative underperformance: 3%
Under a symmetric structure, the AMC should not receive only the upside of the arrangement. Its applicable fee may need to decrease according to the scheme’s disclosed methodology.
This is only a simplified illustration. Actual fees would depend on the scheme documents and SEBI’s applicable framework.
Why Performance-Linked Fees Could Benefit Investors
Better Alignment Between Investors and Fund Managers
Under the traditional model, an AMC’s revenue can rise as its assets under management increase even if investment performance is ordinary.
Performance-linked fees create a stronger connection between compensation and results.
If additional fees depend on generating genuine outperformance, investors may feel they are paying more for actual value added rather than simply for the size of the fund.
Greater Focus on Benchmark Performance
Performance-linked fees could also make benchmark selection more important.
Investors often look at absolute mutual fund returns.
But an actively managed fund earning 12% when its benchmark earns 16% tells a very different story from a fund earning 12% when the benchmark earns 8%.
This is also central to the debate between active and passive investing. For a detailed comparison, read Index Funds vs Actively Managed Funds: Which Performs Better in India?
Could Make Active Fund Fees Easier to Justify
Active mutual funds typically require research teams, fund managers and portfolio decision-making.
Passive funds, on the other hand, generally aim to replicate an index rather than consistently generate alpha through security selection.
If an active fund charges considerably more than an index fund, investors naturally want to know whether the additional cost is justified by additional performance.
Performance-linked fees could make that relationship more visible.
Investors exploring lower-cost passive strategies can also read about the Best Index Funds in India on Alice Blue.
What Are the Challenges with Performance-Linked Fees?
Although the idea sounds straightforward, implementing it in an open-ended mutual fund is considerably more complicated.
Choosing the Right Benchmark
A performance fee only makes sense when the benchmark is appropriate.
For example, comparing a small-cap strategy with the Nifty 50 would not provide a fair representation of fund-manager skill.
Benchmarks therefore need to closely reflect the investment mandate and risk profile of the scheme.
Otherwise, a fund could appear to generate impressive outperformance simply because the benchmark is unsuitable.
Different Investors Enter at Different Times
Unlike some closed investment structures, open-ended mutual funds continuously receive purchases and redemptions.
One investor may enter in January, another in June and another in December.
Each investor experiences a different return period.
This makes a fair performance-linked fee calculation more complicated than simply looking at the fund’s calendar-year return.
Industry experts have highlighted these calculation and operational difficulties as one reason performance-linked fees have historically been difficult to implement in open-ended mutual funds.
Potential Incentive to Take More Risk
There is another important issue.
If fund managers can earn higher fees by significantly outperforming a benchmark, they could theoretically have an incentive to take greater risks.
That is why safeguards around symmetry, benchmarks, fee limits, disclosures and risk management become important.
Outperformance alone does not necessarily mean good fund management. Investors should also consider how much risk was taken to produce those returns.
Performance-Linked Fees and SEBI's New BER Framework
Performance-linked fees form part of a wider restructuring of mutual fund expenses under the 2026 regulations.
SEBI has introduced the Base Expense Ratio (BER) framework to create greater clarity around what investors are paying.
The broader expense structure separates the base expenses from certain brokerage, transaction costs and statutory levies.
For open-ended equity-oriented schemes, the maximum BER under the new slab system begins at 2.10% for the first ₹500 crore of daily net assets, then progressively declines as scheme assets increase. Different limits apply to non-equity schemes and certain categories such as index funds and ETFs.
Investors should therefore distinguish between:
BER: the base permitted scheme expenses.
Other permitted costs: such as applicable brokerage, transaction costs and statutory levies.
Performance-linked component: applicable only where a scheme adopts an eligible performance-based fee structure according to the regulatory framework.
Together, these reforms are aimed at making mutual fund costs more transparent and better aligned with investor outcomes.
Does This Change Direct and Regular Mutual Fund Plans?
Direct and regular plans will continue to be important because their distribution costs differ.
A regular plan generally includes distribution expenses or commissions, while a direct plan excludes such distribution commissions. As a result, direct plans generally have lower expense ratios than corresponding regular plans.
The underlying portfolio of the direct and regular versions of a scheme may be the same, but their NAVs can differ because of differences in expenses.
For a complete explanation, read Regular vs Direct Mutual Fund NAV Explained
Performance-linked fees do not remove the need to compare these costs.
Investors will still need to understand the total expenses applicable to the particular plan they select.
Are Performance-Linked Fees Already Being Used by Mutual Funds?
This is an important distinction.
SEBI has enabled performance-linked fees, but that does not mean all mutual funds—or even most mutual funds—have shifted to this model.
At the Moneycontrol Mutual Fund Summit on June 30, 2026, SEBI Executive Director Manoj Kumar said that the framework was already available but remained largely unused by the mutual fund industry at that stage.
Therefore, investors should not assume that an existing mutual fund automatically follows a performance-linked fee structure.
The applicable Scheme Information Document and other scheme disclosures should specify the actual expense mechanism.
What Should Mutual Fund Investors Check?
If a mutual fund introduces a performance-linked fee model, investors should look beyond the headline claim of “pay for performance.”
Check:
- Which benchmark is being used?
- How is outperformance calculated?
- What happens when the scheme underperforms?
- What is the base expense ratio?
- What is the maximum performance-related fee?
- Over what period is performance measured?
- How does the total cost compare with similar funds?
- Is the fund taking substantially more risk to generate excess returns?
- Is it a Direct or Regular Plan?
- Does the fund consistently add value after expenses?
Costs are important, but they should never be examined in isolation.
Risk, asset allocation, investment objective, consistency, benchmark performance and taxation can all affect the investor’s final return.
For taxation, investors can refer to Alice Blue’s detailed guide on Mutual Fund Taxation in India 2026
Will Performance-Linked Fees Make Mutual Funds Better?
Potentially—but not automatically.
The strongest argument in favour of performance-linked fees is alignment.
If a fund manager generates genuine, consistent outperformance, a carefully designed fee structure could reward that skill. If the fund underperforms, investors should correspondingly benefit from lower fees under a symmetric model.
But performance fees also make mutual funds more complicated.
A simple expense ratio is easy to understand. A fee tied to benchmarks, measurement periods and relative performance requires investors to pay closer attention to how the calculation works.
Ultimately, the quality of the framework will depend on whether it rewards genuine skill without encouraging unnecessary risk-taking.
Conclusion
SEBI’s performance-linked mutual fund fee framework represents an important shift in how mutual fund costs could evolve in India.
Instead of allowing AMC compensation to depend primarily on the amount of money managed, the framework creates the possibility of linking part of the fee to the value generated for investors.
For investors, that sounds attractive.
But the real test will be implementation.
The benchmark must be appropriate, fee calculations must be transparent, underperformance must have consequences for fees, and fund managers should not be encouraged to take excessive risks simply to maximise performance compensation.
For now, performance-linked fees remain an optional framework rather than the standard fee model across the mutual fund industry.
As fund houses begin experimenting with the structure, investors should focus on one question:
After considering performance, risk and all applicable expenses, is the mutual fund actually delivering better value for your money?
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