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Are fund managers incentivised to ignore stock market jumps?

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posted on 2023-08-25, 12:32 authored by Ilias Chondrogiannis, Mark Freeman, Andrew VivianAndrew Vivian

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 Finance

Volume

29

Issue

15

Pages

1793-1823

Publisher

Informa UK Limited

Version

  • 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

2022-12-05

Publication date

2023-01-03

Copyright date

2022

ISSN

1351-847X

eISSN

1466-4364

Language

  • en

Depositor

Prof Andrew Vivian. Deposit date: 4 January 2023

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