Hostname: page-component-cd9895bd7-q99xh Total loading time: 0 Render date: 2024-12-24T18:52:31.733Z Has data issue: false hasContentIssue false
  • English
  • Français

Peer Versus Pure Benchmarks in the Compensation of Mutual Fund Managers

Published online by Cambridge University Press:  06 November 2023

Richard Evans Open the ORCID record for Richard Evans [Opens in a new window] ,
Juan-Pedro Gómez ,
Linlin Ma  and
Yuehua Tang
Richard Evans
Affiliation:
University of Virginia Darden School of Business [email protected]
Juan-Pedro Gómez
Affiliation:
IE University IE Business School [email protected]
Linlin Ma*
Affiliation:
Peking University HSBC Business School
Yuehua Tang
Affiliation:
University of Florida Warrington College of Business [email protected]
*
[email protected] (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

We examine the role of peer (e.g., Lipper manager indices) versus pure (e.g., S&P 500) benchmarks in fund manager compensation. We model their impact on manager incentives and then test those predictions using novel data. We find that 71% of managers are compensated based on peer benchmarks. Consistent with the model, peer-benchmarked fund managers exhibit higher effort generating higher gross performance and collect higher fee income. Analyzing advisors’ choice between benchmark types, we show that peer-benchmarking advisors cater to more sophisticated and performance-sensitive investors, and are more likely to sell through direct channels, consistent with investor heterogeneity and market segmentation.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 7 , November 2024 , pp. 3101 - 3138
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank two anonymous referees, Li An, Matthijs Breugem, Jennifer Conrad (the editor), Sangeun Ha, Leonard Kostovetsky, Jiacui Li, Pedro Matos, Ľuboš Pástor, Alvaro Remesal, Pablo Ruiz-Verdú, Sergei Sarkissian, Philipp Schuster, Michael Sockin, Yang Song, Sheridan Titman, Youchang Wu, and seminar and conference participants at the 2019 Asset Management Conference at ESMT Berlin, 2021 AEFIN Finance Forum, 2019 PHBS Workshop in Macroeconomics and Finance, 2020 Northern Finance Association Conference, 2021 New Zealand Finance Meeting, CEU Cardenal Herrera University, Collegio Carlo Alberto at the University of Torino, CUNEF University, Oklahoma State University, and the University of Virginia for their comments and suggestions. We also thank Changhyun Ahn, Liling Huang, Michael Del Monte, Andrew Han, Joseph Lally, Anna Potts, and Yuan Wang for excellent research assistance. We acknowledge research support from the Spanish Ministry of Economy and Competitiveness (MCIU), State Research Agency (AEI), and European Regional Development Fund (ERDF; Grant No. PGC2018-101745-A-I00) as well as MCIN/AEI/10.13039/501100011033/FEDER, UE Grant No. PID2021-125359NB-I00. Ma acknowledges financial support from the National Natural Science Foundation of China Youth Project (Grant No. 72103008).

References

Admati, A. R., and Pfleiderer, P.. “Does it all Add Up? Benchmarks and the Compensation of Active Portfolio Managers.” Journal of Business, 70 (1997), 323–350.CrossRefGoogle Scholar
Agarwal, V.; Gómez, J.-P.; and Priestley, R.. “Management Compensation and Market Timing Under Portfolio Constraints.” Journal of Economic Dynamics and Control, 36 (2012), 1600–1625.CrossRefGoogle Scholar
Amihud, Y., and Goyenko, R.. “Mutual Fund’s R2 as Predictor of Performance.” Review of Financial Studies, 26 (2013), 667–694.CrossRefGoogle Scholar
Asness, C. S.; Frazzini, A.; and Pedersen, L. H.. “Quality Minus Junk.” Review of Accounting Studies, 24 (2019), no. 1, 34–112.CrossRefGoogle Scholar
Basak, S., and Pavlova, A.. “Asset Prices and Institutional Investors.” American Economic Review, 103 (2013), 1728–1758.CrossRefGoogle Scholar
Basak, S.; Pavlova, A.; and Shapiro, A.. “Offsetting the Implicit Incentives: Benefits of Benchmarking in Money Management.” Journal of Banking and Finance, 32 (2008), 1883–1893.CrossRefGoogle Scholar
Basak, S.; Shapiro, A.; and Teplá, L.. “Risk Management with Benchmarking.” Management Science, 52 (2006), 542–557.CrossRefGoogle Scholar
Binsbergen, J. H.; Brandt, M. W.; and Koijen, R. S.. “Optimal Decentralized Investment Management.” Journal of Finance, 63 (2008), 1849–1895.CrossRefGoogle Scholar
Bizjak, J. M.; Kalpathy, S. L.; Li, Z. F.; and Young, B.. “The Choice of Peers for Relative Performance Evaluation in Executive Compensation.” Review of Finance, 26 (2022), 1217–1239.CrossRefGoogle Scholar
Brown, D. P., and Wu, Y.. “Mutual Fund Flows and Cross-Fund Learning Within Families.” Journal of Finance, 71 (2016), no. 1, 383–424.CrossRefGoogle Scholar
Brown, K. C.; Harlow, W. V.; and Starks, L. T.. “Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry.” Journal of Finance, 51 (1996), no. 1, 85–110.CrossRefGoogle Scholar
Carhart, M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Chen, J.; Hong, H.; Huang, M.; and Kubik, J. D.. “Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization.” American Economic Review, 94 (2004), 1276–1302.CrossRefGoogle Scholar
Chevalier, J., and Ellison, G.. “Risk Taking by Mutual Funds as a Response to Incentives.” Journal of Political Economy, 105 (1997), no. 6, 1167–1200.CrossRefGoogle Scholar
Cohen, R. B.; Coval, J. D.; and Pástor, L.. “Judging Fund Managers by the Company They Keep.” Journal of Finance, 60 (2005), 1057–1096.CrossRefGoogle Scholar
Cremers, K. M.; Fulkerson, J. A.; and Riley, T. B.. “Benchmark Discrepancies and Mutual Fund Performance Evaluation.” Journal of Financial and Quantitative Analysis, 57 (2022), no. 2, 543–571.CrossRefGoogle Scholar
Cremers, M., and Petajisto, A.. “How Active Is Your Fund Manager? A New Measure that Predicts Performance.” Review of Financial Studies, 22 (2009), 3329–3365.CrossRefGoogle Scholar
Cremers, M.; Petajisto, A.; and Zitzewitz, E.. “Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation.” Critical Finance Review, 2 (2012), 1–48.CrossRefGoogle Scholar
Cuoco, D., and Kaniel, R.. “Equilibrium Prices in the Presence of Delegated Portfolio Management.” Journal of Financial Economics, 101 (2011), 264–296.CrossRefGoogle Scholar
Daniel, K.; Grinblatt, M.; Titman, S.; and Wermers, R.. “Measuring Mutual Fund Performance with Characteristic-Based Benchmarks.” Journal of Finance, 52 (1997), 1035–1058.Google Scholar
Das, S. R., and Sundaram, R. K.. “Fee Speech: Signalling, Risk-Sharing, and the Impact of Fee Structures on Investor Welfare.” Review of Financial Studies, 15 (2002), 1465–1497.CrossRefGoogle Scholar
Del Guercio, D., and Reuter, J.. “Mutual Fund Performance and the Incentive to Generate Alpha.” Journal of Finance, 69 (2014), 1673–1704.CrossRefGoogle Scholar
Dybvig, P. H.; Farnsworth, H. K.; and Carpenter, J. N.. “Portfolio Performance and Agency.” Review of Financial Studies, 23 (2010), 1–23.CrossRefGoogle Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “A First Look at the Accuracy of the CRSP Mutual Database and a Comparison of the CRSP and Morningstar Mutual Fund Databases.” Journal of Finance, 56 (2001), 2415–2430.CrossRefGoogle Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “Incentive Fees and Mutual Funds.” Journal of Finance, 58 (2003), 779–804.CrossRefGoogle Scholar
Evans, R. B. “Mutual Fund Incubation.” Journal of Finance, 65 (2010), 1581–1611.CrossRefGoogle Scholar
Evans, R. B.; Prado, M. P.; and Zambrana, R.. “Competition and Cooperation in Mutual Fund Families.” Journal of Financial Economics, 136 (2020), 168–188.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116 (2015), no. 1, 1–22.CrossRefGoogle Scholar
Frazzini, A.; Friedman, J. A.; and Pomorski, L.. “Deactivating Active Share.” Financial Analysts Journal, 72 (2016), 14–21.CrossRefGoogle Scholar
Frazzini, A., and Pedersen, L. H.. “Betting Against Beta.” Journal of Financial Economics, 111 (2014), no. 1, 1–25.CrossRefGoogle Scholar
Gârleanu, N.; Panageas, S.; and Yu, J.. “Impediments to Financial Trade: Theory and Applications.” Review of Financial Studies, 33 (2020), 2697–2727.CrossRefGoogle Scholar
Golec, J., and Starks, L.. “Performance Fee Contract Change and Mutual Fund Risk.” Journal of Financial Economics, 73 (2004), 93–118.CrossRefGoogle Scholar
Gómez, J.-P., and Sharma, T.. “Portfolio Delegation Under Short-Selling Constraints.” Economic Theory, 28 (2006), 173–196.CrossRefGoogle Scholar
Heinkel, R., and Stoughton, N. M.. “The Dynamics of Portfolio Management Contracts.” Review of Financial Studies, 7 (1994), 351–387.CrossRefGoogle Scholar
Hölmstrom, B. “Moral Hazard and Observability.” Bell Journal of Economics, 10 (1979), 74–91.CrossRefGoogle Scholar
Hunter, D.; Kandel, E.; Kandel, S.; and Wermers, R.. “Mutual Fund Performance Evaluation with Active Peer Benchmarks.” Journal of Financial Economics, 112 (2014), 1–29.CrossRefGoogle Scholar
Ibert, M.; Kaniel, R.; Nieuwerburgh, S. v.; and Vestman, R.. “Are Mutual Fund Managers Paid for Investment Skill?” Review of Financial Studies, 31 (2018), 715–772.CrossRefGoogle Scholar
Kapur, S., and Timmermann, A.. “Relative Performance Evaluation Contracts and Asset Market Equilibrium.” Economic Journal, 115 (2005), 1077–1102.CrossRefGoogle Scholar
Kashyap, A. K.; Kovrijnykh, N.; Li, J.; and Pavlova, A.. “Is There Too Much Benchmarking in Asset Management?” American Economic Review, 113 (2023), 1112–1141.CrossRefGoogle Scholar
Lee, J. H.; Trzcinka, C.; and Venkatevan, S.. “Do Portfolio Manager Contracts Contract Portfolio Management?” Journal of Finance, 74 (2019), 2543–2577.CrossRefGoogle Scholar
Li, C. W., and Tiwari, A.. “Incentive Contracts in Delegated Portfolio Management.” Review of Financial Studies, 22 (2009), 4681–4714.CrossRefGoogle Scholar
Ma, L.; Tang, Y.; and Gómez, J.-P.. “Portfolio Manager Compensation in the U.S. Mutual Fund Industry.” Journal of Finance, 74 (2019), 587–638.CrossRefGoogle Scholar
Ou-Yang, H. “Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem.” Review of Financial Studies, 16 (2003), 173–208.CrossRefGoogle Scholar
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), no. 3, 642–685.CrossRefGoogle Scholar
Pástor, L.; Stambaugh, R. F.; and Taylor, L. A.. “Scale and Skill in Active Management.” Journal of Financial Economics, 116 (2015), 23–45.CrossRefGoogle Scholar
Sensoy, B. A. “Performance Evaluation and Self-Designated Benchmark Indexes in the Mutual Fund Industry.” Journal of Financial Economics, 92 (2009), no. 1, 25–39.CrossRefGoogle Scholar
Servaes, H., and Sigurdsson, K.. “The Costs and Benefits of Performance Fees in Mutual Funds.” Journal of Financial Intermediation, 50 (2022), 100959.CrossRefGoogle Scholar
Sirri, E. R., and Tufano, P.. “Costly Search and Mutual Fund Flows.” Journal of Finance, 53 (1998), 1589–1622.CrossRefGoogle Scholar
Sockin, M., and Xiaolan, M. Z.. “Delegated Learning and Contract Commonality in Asset Management.” Review of Finance, 27 (2023), 1931–1975.CrossRefGoogle Scholar
Stambaugh, R. F., and Yuan, Y.. “Mispricing Factors.” Review of Financial Studies, 30 (2017), no. 4, 1270–1315.CrossRefGoogle Scholar
Stoughton, N. “Moral Hazard and the Portfolio Management Problem.” Journal of Finance, 48 (1993), 2009–2028.CrossRefGoogle Scholar
Supplementary material: File

Evans et al. supplementary material

Evans et al. supplementary material
Download Evans et al. supplementary material(File)
File 106.4 KB