Are fund managers incentivised to ignore stock market jumps?
In this paper, we show that the way in which fund managers are compensated can, under plausible conditions, lead them to act in a way that does not maximise the wellbeing of their clients. Due to performance bonuses in fund managers' rewards, there is a highly non-linear relationship between the wealth of the client and the fees that the manager receives. We demonstrate that jumps in equity returns can lead to a conflict of interest between the investor and the manager in such a setting. Specifically, the managers' option-type payment structure can incentivise them to not account for the downside risk induced by jumps, especially if the fund manager is only in post for a few years; thus managers may pursue a more aggressive asset allocation strategy than their clients desire. Our key policy recommendation is that regulators should consider imposing a negative fund fee in times of very poor absolute fund performance to mitigate against suboptimal fund management asset allocation decisions.
History
School
- Loughborough Business School
Department
- Business
Published in
The European Journal of FinanceVolume
29Issue
15Pages
1793-1823Publisher
Informa UK LimitedVersion
- VoR (Version of Record)
Rights holder
© The Author(s)Publisher statement
This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives License (http://creativecommons.org/licenses/by-nc-nd/4.0/), which permits non-commercial re-use, distribution, and reproduction in any medium, provided the original work is properly cited, and is not altered, transformed, or built upon in any way.Acceptance date
2022-12-05Publication date
2023-01-03Copyright date
2022ISSN
1351-847XeISSN
1466-4364Publisher version
Language
- en