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.
- Loughborough Business School
Published inThe European Journal of Finance
PublisherInforma UK Limited
- VoR (Version of Record)
Rights holder© The Author(s)
Publisher statementThis 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.