If a fund has a fee, say 2%, does the fund company take that 2% fee, even if there's a loss for the portfolio? -- Cheryl Kohl

Cheryl,

Mutual-fund companies aren't big on giving rebates.

So don't expect to get money back if your fund trails the

S&P 500

year after year after year.

Performance-adjusted fees are rare in the mutual fund business. Thankfully, they do exist at some of the nation's major money managers, including

Fidelity

,

Vanguard

and

AIM

.

Most mutual funds charge a flat percentage to manage your money. (The management fee is part of the expense ratio along with the operating expenses and any 12b-1 fees.) Whether those funds deliver spectacular or pathetic performance, they get to keep the same amount of money.

However some funds do adjust their fees based on how they perform against a designated benchmark. If the fund beats that benchmark over a certain period, then it gets to charge a slightly higher management fee. If it fails to top that index, then it takes a lower fee.

These fees give the manager some extra incentive to deliver superior returns. If the shareholders are enduring pathetic performance, the fund company suffers right along with them. If a manager falls down on the job, you give up less money to the management fee.

To an individual investor, any amount saved might be quite small -- just a few dollars for some -- but these fee adjustments do represent a good-faith effort on the part of firms to deliver superior performance. A large fund company might stand to gain or lose a lot of money with these performance fees in place, which would certainly give a fund firm some extra monetary motivation.

"

Performance-based fees are definitely beneficial," says Scott Cooley, a senior analyst at

Morningstar

. "I think most fund families just aren't up to the challenge."

Obviously, they aren't.

Only 74 out of 2,706 U.S. equity funds carry performance-based management fees, according to Morningstar.

Fund colossus Fidelity, by far, dominates that field.

Of the 162 retail funds at Fidelity, 34 funds, including

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Magellan,

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Large Cap Stock and

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Mid-Cap Stock, adjust their management fees based on performance.

(Last year, Fidelity did eliminate performance fees on

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Destiny I and

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Destiny II but argued that the move was necessary due to the 12b-1 fee on a new class of shares that would have reduced returns.)

In the case of Magellan, the basic management fee -- 0.58% at last look -- is subject to an upward or downward adjustment based on whether the fund beats or trails the S&P 500 over the trailing 36 months. The maximum annualized-adjustment rate is plus or minus 0.2% of the fund's average net assets over the performance period. The performance comparison is made at the end of each month.

For every percentage point that the fund beats or trails the index (up to a maximum difference of plus or minus 10 percentage points), Fidelity keeps two extra basis points or gives back two basis points to shareholders.

That adjustment is rather modest when you look at your own assets. If Magellan gives up the maximum 0.2% in a year, you're only saving $200 if you have $100,000 invested in the fund. (This fund is closed to new investors.)

However, those incentive fees can add up when you are talking about a $109 billion fund. For the fiscal years ending March 31, 1999, 1998 and 1997, Magellan discounted its fee by more than $300 million for the three years combined.

On the upside, performance fees can be worth millions in extra dollars if the funds beat their benchmarks over the three-year period.

As you see, these performance adjustments can cause a fund company to lose profits when and if their funds are struggling. This detail is one of the excuses used to explain why more fund companies don't use employ these fees.

"This could hurt a fund company's earnings in a down market," says mutual-fund consultant Geoff Bobroff. The fees can also make a firm's revenue and earnings unpredictable and volatile, which would be more problematic at a publicly traded fund company.

An additional risk is that shareholders could end up with a more volatile fund. "The bar forces the manager to potentially take greater risks," Bobroff adds.

Another disadvantage: These fee adjustments aren't simple to calculate, which makes them hard to describe to investors. Actually, these calculations can read like the ingredients on a box of cereal.

But enough with the excuses. These performance adjustments send a message to shareholders that the management company is willing to make some sacrifices if the manager doesn't deliver acceptable performance.

"It is the perfect alignment of interests between the shareholder and portfolio manager," say Vanguard spokesman John Demming. Most of Vanguard's actively managed funds, including

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Windsor, carry performance fees. (Of course, it wouldn't make sense for an index fund to have one, since its goal is to track the benchmark rather than beat it.)

If Fidelity and Vanguard can use them, other fund companies can certainly put them on new funds they are launching.

AIM has done just that with its Large Cap Opportunities,

(AMCOX)

Mid Cap Opportunities and

(ASCOX)

Small Cap Opportunities funds. All three funds were launched within the past two years and all three carry performance-adjusted fees. (The Mid Cap and Small Cap funds are closed to new investors.)

You can look in a fund's annual or semi-annual report to see if it carries a performance-adjusted fee or simply ask a fund-company representative. If you don't find one, demand it.

That might make your manager work harder.