Working Paper: CEPR ID: DP17042
Authors: Herve Roche; Nicolas Sahuguet
Abstract: In the managed fund industry, compensation is performance-based and is evaluated with respect to a benchmark. The benchmarks can be an exogenous absolute index or the performance of comparable funds. We analyze the impact of a convex compensation scheme based on peer-group benchmarks. We develop a model of tournament between risk- averse fund managers who receive a fee proportionally to the return differential between their fund and the benchmark, provided that they beat the benchmark. We find that a more competitive benchmark leads to more risk-taking and more differentiated investment strategies. A more competitive (larger) industry provides similar incentives.
Keywords: strategic portfolio allocation; incentive fees; managed fund industry; tournaments; peer-comparison benchmarks
JEL Codes: C61; C73; D81; G11; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| More competitive benchmark (L13) | Increased risk-taking (G41) |
| Size of the industry (L25) | More extreme risk-taking (G40) |