Delegated portfolio management with career concerns

Journal of Financial Intermediation, 2011

Following extensive empirical evidence about "market anomalies" and overconfidence, the analysis of financial markets with agents overconfident about the precision of their private information has received a lot of attention. However, all these models consider agents trading for their own account.

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.

2015

This conference will review recent advances in delegated portfolio management. The main objective of the conference is to confront decades of advances in academic and empirical finance to the state of practice of delegated portfolio management. The subject of delegated management has been around for more than 30 years and hundreds of research evidence has been published on this subject. Despite all these academic evidence about delegated portfolio management, the industry only slowly adapts its practice to these facts.- Why practitioners are so reluctant to integrate in their practice academic evidences? Because of the increasing complexity of financial markets, the difficulty to out-perform benchmarks and the high cost to manage money in-house, many pension funds and individual investors have opted to manage their financial assets through a delegated portfolio manager for active investing or used passive investing. Then, in most industrialized countries, a substantial part of finan...

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.

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.

2005

Utilizing a database of daily institutional fund manager trades, we examine the contribution of strategic trading at quarter-end associated with potential 'portfolio pumping' or 'ramping up' of reported stock prices around quarter ends. We provide the first direct evidence that active fund managers tend to purchase illiquid stocks on the last day of the quarter, in stocks in which they already hold overweight portfolio positions. Consistent with the way fund managers are evaluated, we find the poor-performing managers display greater evidence of portfolio pumping. Both increased regulatory scrutiny and improvements to market microstructure design reduce the severity of stock price changes at quarter ends.

American Economic Review, 2012

We propose a model where investors hire fund managers to invest either in risky bonds or in riskless assets. Some managers have superior information on the default probability. Looking at the past performance, investors update beliefs on their managers and make firing decisions. This leads to career concerns which affect investment decisions, generating a positive or negative "reputational premium". For example, when the default probability is high, uninformed managers prefer to invest in riskless assets to reduce the probability of being fired. As the economic and financial conditions change, the reputational premium amplifies the reaction of prices and capital flows.

New J Phys, 2010

Despite the availability of very detailed data on financial market, agent-based modeling is hindered by the lack of information about real trader behavior. This makes it impossible to validate agent-based models, which are thus reverse-engineering attempts. This work is a contribution to the building of a set of stylized facts about the traders themselves. Using the client database of Swissquote Bank SA, the largest on-line Swiss broker, we find empirical relationships between turnover, account values and the number of assets in which a trader is invested. A theory based on simple mean-variance portfolio optimization that crucially includes variable transaction costs is able to reproduce faithfully the observed behaviors. We finally argue that our results bring into light the collective ability of a population to construct a mean-variance portfolio that takes into account the structure of transaction costs.

New Journal of Physics, 2010

Despite the availability of very detailed data on financial market, agent-based modeling is hindered by the lack of information about real trader behavior. This makes it impossible to validate agent-based models, which are thus reverse-engineering attempts. This work is a contribution to the building of a set of stylized facts about the traders themselves. Using the client database of Swissquote Bank SA, the largest on-line Swiss broker, we find empirical relationships between turnover, account values and the number of assets in which a trader is invested. A theory based on simple mean-variance portfolio optimization that crucially includes variable transaction costs is able to reproduce faithfully the observed behaviors. We finally argue that our results bring into light the collective ability of a population to construct a mean-variance portfolio that takes into account the structure of transaction costs.

Journal of Mathematical Finance, 2013

We investigate the impact of delegated portfolio management on asset prices in a noisy rational equilibrium model. Asset prices in our model are linear in fund managers' private signals and in realized supply shocks. We show that equilibrium expected returns 1) decrease as the proportion of fund managers increase in the economy; 2) decrease as the precision of fund managers' signals increase' and 3) increase as the fund managers' contingent fees increase.