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Mutual Funds

Double or Nothing

You pay no management fees if the bosses fail to measure up.

Mutual funds that link management fees to performance are about as common as blackjack players who beat the house -- it happens, but not often.

According to Lipper, 194 funds collect more when they beat a predesignated benchmark and take less when they trail it. Vanguard and Fidelity, in particular, deserve credit for often putting their money where their numbers are.

But no fund manager has yet gone as far as tiny TFS Capital in risking its payday. The Richmond company is prepared to forfeit its entire management fee if its new TFS Small Cap fund (symbol TFSSX; 888-534-2001) fails to measure up against the Russell 2000 index of small-company stocks.

The fund's base management fee is set at 1.25% per year. After the fund reaches its first birthday next March, the fee will vary monthly based on how the fund performed against the Russell 2000 over the previous 12 months.

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TFS Capital keeps the full fee if the fund tops the index by 2.5 percentage points. The management fee rises to 2.5% if the fund prevails over the index by five percentage points or more. But if the fund matches the Russell 2000 or trails it, TFS Capital forgoes its entire management fee. (The fee is one component of the expense ratio; if TFS's management fee is 1.25%, the expense ratio will be 1.75%.)

TFS Small Cap, which uses a computer-driven approach to picking stocks, had $2 million in assets as of May 15. From the fund's launch on March 7 to May 15, it gained 4%. Over that period, the Russell 2000 gained 2%. There's no guarantee, of course, that a performance-based fee will lead to better results. But we can't help thinking that managers who could lose all or part of their fee will try harder to keep that from happening.