Another problem with point 3 is it also gives the manager the incentive to stop trading the fund if the drawdown is viewed as too high to overcome. If it would take 2 years, for example, to get back above a 30% loss where's the incentive to keep trading the Fund and receive no income during that 2 year period? The manager would be better off to start another fund, like you mentioned, or even trade his or her own account and keep 100% of the profits. And, a 2%, 20% is not a bad deal if the 2% is based on profitability. Agree with the OP, no fund manager should get paid for losing investor's money. The 2% on profitability does, however, give the manager an incentive to deliver a nice return without over-exposure to risk. If the manager collects only the 20% then he has an incentive to juice up the position sizes. If a manager does 25% or 30% or even a sliding scale he/she also has an incentive to take on more risk. Giving the manager 2% based on profitability is a good deal because the manager doesn't feel the need to swing for the fences and reach a 100% return to collect an additional check. Theoretically, the managed capital will exceed profit capital so it gives the manager an incentive to work, but not the incentive to go too large. Excellent post by the OP!