Delegated Learning and Contract Commonality in Asset Management (original) (raw)

Delegated Learning in Asset Management

SSRN Electronic Journal, 2018

We develop a tractable framework of delegated asset management with information acquisition in a multi-asset economy in which fund managers face moral hazard in portfolio allocation decisions. In our setting, benchmarking arises endogenously as part of the contract between investors and active fund managers, and we highlight a novel contract externality in which prices feed back to the contract. Our framework sheds light on a tension between the incentives of active managers to trade on their acquired private information, and both their hedging demand for the benchmark portfolio and the risk-return trade-off of the underlying assets. These insights allow us to uncover a potential gap between our model-implied measure and several widely-adopted empirical statistics intended to capture managerial ability. In a multi-period extension of our model, we propose a new measure of fund manager skill.

Equilibrium prices in the presence of delegated portfolio management

This paper analyzes the asset pricing implications of commonly used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio. The contract parameters, the extent of delegation, and equilibrium prices are all determined endogenously within the model we consider. Symmetric (fulcrum) performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the Sharpe ratios. Asymmetric performance fees have more complex effects on equilibrium prices and Sharpe ratios, with the signs of these effects fluctuating stochastically over time in response to variations in the funds’ excess performance.

Decentralized Investment Management: Evidence from the Pension Fund Industry

The Journal of Finance, 2013

Wermers is from Smith School of Business, University of Maryland at College Park. We are especially grateful to the Rotman International Centre for Pension Management (ICPM) at the University of Toronto as well as Inquire-U.K. for financial support. Members of the board of the ICPM research committee also provided insightful suggestions for improving our paper. We are also grateful to Alan Wilcock and Daniel Hall of BNY Mellon Asset Servicing for providing us with the CAPS pension fund performance data and for patiently answering an endless list of questions concerning the data. Rosalin Wu provided excellent research assistance on this project. The paper has benefitted from comments made at presentations at the Abstract The past few decades have seen a major shift from centralized to decentralized investment management by pension fund sponsors, despite the increased coordination problems that this brings. Using a unique, proprietary dataset of pension sponsors and managers, we identify two secular decentralization trends: sponsors switched (i) from generalist (balanced) to specialist managers across asset classes and (ii) from single to multiple competing managers within each asset class. We study the effect of decentralization on the risk and performance of pension funds, and find evidence supporting some predictions of recent theory on this subject.

Fee Speech: Signaling, Risk-Sharing, and the Impact of Fee Structures on Investor Welfare

Review of Financial Studies, 2002

The fee structure used to compensate investment advisers is central to the study of fund design, and affects investor welfare in at least three ways: (i) by influencing the portfolio-selection incentives of the adviser, (ii) by affecting risk-sharing between adviser and investor, and (iii) through its use as a signal of quality by superior investment advisers. In this paper, we describe a model in which all of these features are present, and use it to compare two popular and contrasting forms of fee contracts, the "fulcrum" and the "incentive" types, from the standpoint of investor welfare. While the former has some undeniably attractive features (that have, in particular, been used by regulators to justify its mandatory use in a mutual fund context), we find surprisingly that it is the latter that is often more attractive from the standpoint of investor welfare. Our model is a flexible one; our conclusions are shown to be robust to many extensions of interest. The results are also extended to consider unrestricted fee structures and competitive markets for fund managers.

More competition in delegated portfolio management: A win-win situation? An experimental analysis

Journal of Economic Behavior & Organization

With a novel design, we investigate how competition between fund managers and disclosure of other managers' fees and performance influence fees, risk taken, earnings and investor concentration in a fund management experiment. We find that more competition and disclosure leads to a significant reduction of fees-the relative decrease being larger for Management Fees than for Performance Fees. While the decrease in fees does not a↵ect manager's investment strategies, it significantly increases investors' readiness to entrust their funds to a manager. This leads to higher overall earnings, with the benefits going to investors and those fund managers who are able to attract investors. While there is an extensive literature arguing that a competitive environment may lead to unwanted outcomes, our results suggest that more competition is mostly beneficial to investors and those fund managers that succeed in attracting investors.

NBER WORKING PAPER SERIES ASSET MANAGEMENT CONTRACTS AND EQUILIBRIUM PRICES We thank

We derive equilibrium asset prices when fund managers deviate from benchmark indices to exploit noise-trader induced distortions but fund investors constrain these deviations. Because constraints force managers to buy assets that they underweight when these assets appreciate, overvalued assets have high volatility, and the risk-return relationship becomes inverted. Noise traders bias prices upward because constraints make it harder for managers to underweight overvalued assets, which have high volatility, than to overweight undervalued ones. We endogenize the constraints based on investors' uncertainty about managers' skill, and show that asset-pricing implications can be significant even for moderate numbers of unskilled managers. 4 and Sannikov (2014)). By contrast, distortions in our model are more pronounced for overvalued assets and during up markets.

Delegated Portfolio Management and Risk Taking Behavior

Standard models of moral hazard predict a negative relationship between risk and incentives; however empirical studies on mutual funds present mixed results. In this paper, we propose a behavioral principal-agent model in the context of professional managers, focusing on active and passive investment strategies. Using this general framework, we evaluate how incentives affect the risk taking behavior of managers, using the standard moral hazard model as a special case. Our propositions suggest that managers of passively managed funds tend to be risk averse and tend to be rewarded without incentive fees. On the other hand, in actively managed funds, whether incentives reduce or increase the riskiness of the fund depends on how hard it is to outperform the benchmark. If the fund is likely to outperform the benchmark, incentives reduce the manager's risk appetite. Furthermore, the evaluative horizon influences the trader's risk preferences, in the sense that if traders performed poorly in a period, they tend to choose riskier investments in the following period given the same evaluative horizon. If the fund is unlikely to outperform the benchmark, the opposite is true; incentives cause increased risk taking, and if traders performed well in a given time period, they tend to choose more conservative investments following that time period.

Equilibrium Incentives to Acquire Precise Information in Delegated Portfolio Management

Journal of Financial Services Research, 2004

This paper investigates how a linear contract offered to a portfolio manager affects her incentives to acquire precise information. I show that increasing the manager's portfolio share increases her demand for precise information. This result contrasts with the existing irrelevance results where the manager's portfolio share does not affect her precision choice. The irrelevance result relies on the manager facing a constant asset price, regardless of her demand. In a noisy rational expectations framework, increasing the manager's share decreases her demand and results in a less informative asset price. Thus, the manager gathers more precise information when offered a larger fraction of portfolio returns.

Equilibrium Implications of Delegated Asset Management under Benchmarking

Review of Finance, 2012

Despite the enormous growth of the asset management industry during the past decades, little is known about the asset pricing implications of investment intermediaries. Standard models of investment theory do not address the distinction between individual and institutional investors nor the potential implications of direct investing and delegated investing. In a model with endogenous delegation, we find that delegation leads to a more informative price system and lower equity premia. In the presence of relative return objectives, stocks exhibiting high correlations with the benchmark have significantly lower returns than stocks with low correlations. Our empirical results support the model's predictions.