The concept of incentive fee (also called performance fee) is used in conventional finance to encourage fund managers to improve their performance level and provide the best return for their clients. It is a common feature of most alternative investment funds and is a fundamental part of the remuneration of many hedge fund investment managers. The incentive fee is defined as a fee paid to the fund manager as compensation for raising his performance level in managing the fund over a given period. It represents an additional fee that investors are required to pay in addition to an annual fee for the manager.
As the Islamic finance industry became more sophisticated in the products and services it offered, the incentive fee was adopted in its various sectors, including Islamic banking, takāful, and the Islamic capital market. Nonetheless, the basis for applying the concept in these products from the Islamic viewpoint has remained vague, particularly its fiqhī characterization (takyīf fiqhī). While the Shariah Advisory Council of Securities Commission Malaysia (SAC-SC) considers it as tanāzul (relinquishment of a right to another party) in the context of ṣukūk, AAOIFI suffices by calling it an incentive fee (ḥāfiz tashjīʿī). In addition, although scholars allow the application of incentive fees in most Islamic banking (IB) and Islamic capital market (ICM) products, they have differing views on its application in takāful.
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