More competition in delegated portfolio management: A win-win situation? An experimental analysis (original) (raw)
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Competition in Portfolio Management: Theory and Experiment
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We study the impact of delegated portfolio management on asset pricing in a large-scale experimental setting. With a few exceptions, models of asset pricing are formulated in terms of the preference functions of final investors. This effectively assumes that adding a layer of management does not affect market equilibrium. In early rounds of our experiments, delegation indeed has no impact on pricing; we replicate CAPM pricing as in earlier experiments without delegation. Choices are also in line with prior evidence. CAPM pricing fails in later rounds, however, and we even observe a negative equity premium. We attribute this to fund flows. Investors tend to increase allocations to managers who performed well in the past (not just the previous period). Moreover, fund flows implicitly reflect a reward for variance. As a result, funds become concentrated with a few managers, and the aggregation of deviations of individual manager demands from mean-variance optimality, needed to ensure CAPM pricing, no longer obtains. Given the predominance of delegated investing in actual equity markets, our results have important implications for asset pricing theory.
Experimental Economics, 2013
As we described in Section 2, a typical hedge fund contract specifies a pair (w, β) which represents a watermark w and a share β of profits above watermark that managers keeps for himself. We will show below that, if β ≥β > 0 1 , then there exists an equilibrium in which all the funds are invested in the risky project. We will show that we can sustain an equilibrium in which both managers propose contract with w = R r , β ∈ [β, 1] and invest in the risky project. First, similarly to the Result 1, if w > w * then a manager will prefer to invest in the risky project because Π manager w,β,safe
Markets for Other People's Money: An Experimental Study of the Impact of the Competition for Funds
In this paper we experimentally investigate the impact that competing for funds has on the risk-taking behavior of laboratory hedge fund managers. We construct a simple laboratory market for capital among hedge funds where each fund o¤ers a contract that shares a stylized version of various features that are commonly observed in real-world markets of this type. We …nd that commonly used hedge fund contracts leads to ine¢ cient risk taking behavior on the part of investors. We then construct a number of di¤erent contractual environments which vary the transparency of the contracts o¤ered, their risk sharing component, their maximum return etc. and …nd that while all of these treatments prove to substantially reduce risk taking among fund managers, the most e¢ cient is our transparency treatment. Finally, we …nd an "Other People's Money" e¤ect where fund managers tend to invest the funds of their investors in a more risky manner than their own money.
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.
Mutual Fund Competition and Fund Manager Strategy Choice
Mutual Funds, 2020
The increasing number of mutual funds and assets under management of the industry are credited with restricting opportunities and stifling incentives for fund managers to generate alpha. I show that some managers are able to adapt to the more competitive market environment by tilting their investment strategy towards 'quality'. Using the fund's loading on the QMJ factor to proxy for quality management, I find that high quality funds outperform their peers, and generate annual alphas of 2.88%. Besides peer competition, a clientele effect seems to influence the choice of strategy. Clients of high quality funds are more sophisticated and focus on risk-adjusted returns, while those of low quality funds fit the description of uninformed investors, and seem unresponsive to both gross returns and alphas.
The Journal of Law and Economics, 2004
Mutual funds must disclose their portfolio holdings to investors semiannually. The costs and benefits of such disclosures are a long-standing subject of debate. For actively managed funds, one cost of disclosure is a potential reduction in the private benefits from research on asset values. Disclosure provides public access to information on the assets that the fund manager views as undervalued. This paper tries to quantify this potential cost of disclosure by testing whether "copycat" mutual funds, funds that purchase the same assets as actively-managed funds as soon as those asset holdings are disclosed, can earn returns that are similar to those of the actively-managed funds. Copycat funds do not incur the research expenses associated with the actively-managed funds that they are mimicking, but they miss the opportunity to invest in assets that managers identify as positive return opportunities between disclosure dates. Our results for a limited sample of high expense funds in the 1990s suggest that while returns before expenses are significantly higher for the underlying actively managed funds relative to the copycat funds, after expenses copycat funds earn statistically indistinguishable, and possibly higher, returns than the underlying actively managed funds. These findings contribute to the policy debate on the optimal level and frequency of fund disclosure.
Compensation and Managerial Herding: Evidence from the Mutual Fund Industry
SSRN Electronic Journal, 2007
We test the corporate theory of managerial herding based on reputation and career concerns (Scharfstein and Stein, 1990) by focusing on the mutual fund industry. We investigate the trade-off between reputation and compensation and study how incentives in the advisory contract affect managerial herding and risk taking. We consider two types of herding: category herding-the choice of operating in a category in which it is easier to preserve reputation, and stock herding-the choice of a trading strategy similar to the ones of the competitors. We show that a high incentive contract induces entry in categories in which an extreme performance realization is more likely, the adoption of trading strategies different from the ones being followed by other funds and higher risk taking. Family affiliation reduces (increases) the tendency to herd (to take risk) and, therefore, reduces the need for high incentive contracts. Moreover, unobserved actions of mutual funds with high incentive contracts induce managers to take performance-enhancing unobserved actions.
How Does Simplified Disclosure Affect Individuals' Mutual Fund Choices?
2009
We use an experiment to estimate the effect of the SEC's Summary Prospectus, which simplifies mutual fund disclosure. Our subjects chose an equity portfolio and a bond portfolio. Subjects received either statutory prospectuses or Summary Prospectuses. We find no evidence that the Summary Prospectus affects portfolio choices. Our experiment sheds new light on the scope of investor confusion about sales loads. Even with a one-month investment horizon, subjects do not avoid loads. Subjects are either confused about loads, overlook them, or believe their chosen portfolio has an annualized log return that is 24 percentage points higher than the load-minimizing portfolio.
Moral Hazard in Mutual Fund Management: The Quality-Assuring Role of Fees
RePEc: Research Papers in Economics, 2012
We model the role of fees in assuring the quality of active mutual fund management. Active management is an experience good subject to moral hazard; investors cannot tell high quality from low quality until after the fact. An active manager might promise to incur costly e↵ort researching profitable portfolio selection in exchange for a fee su cient to compensate for his higher research costs. If investors were to find this promise credible, they would buy shares until their expected returns, net of fees, just equalled investing in, say, the market index. The manager might then shirk by forgoing costly research ('closet index') and pocket the excess fee, leaving investors worse o↵ than if they had simply invested in the index. We model this moral hazard and show how it can be mitigated by paying the manager a premium fee su ciently high that the one-time gain from shirking is less than the capitalized value of the premium stream the manager earns from maintaining his promise to provide high quality. Investors benefit from higher fees, rather than lower fees, which act as a 'quality assuring bond', or 'e ciency wage'. Where quality is unobservable, any attempt to impose binding maximum fees will make investors worse o↵. Our model has a number of revealing extensions and comparative statics.