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ESSAYS ON DELEGATED PORTFOLIO MANAGEMENT UNDER MARKET
IMPERFECTIONS
by
Juan Mart n Sotes-Paladino
A Dissertation Presented to the
FACULTY OF THE USC GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Ful llment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(BUSINESS ADMINISTRATION)
May 2012
Copyright 2012 Juan Mart n Sotes-Paladino
Object Description
| Title | Essays on delegated portfolio management under market imperfections |
| Author | Sotes-Paladino, Juan Martín |
| Author email | sotespal@usc.edu;jmsotesp@yahoo.com.ar |
| Degree | Doctor of Philosophy |
| Document type | Dissertation |
| Degree program | Business Administration |
| School | Marshal School of Business |
| Date defended/completed | 2012-03-21 |
| Date submitted | 2012-04-26 |
| Date approved | 2012-04-27 |
| Restricted until | 2012-04-27 |
| Date published | 2012-04-27 |
| Advisor (committee chair) | Zapatero, Fernando |
| Advisor (committee member) |
Albagli, Elias Matos, Pedro Ma, Jin |
| Abstract | This dissertation consists of three chapters of interrelated work in the area of delegated portfolio management. The common topic across the three chapters is the interaction of agency conflicts in the relation between a delegating household and a portfolio manager on the one hand, and additional market frictions such as asymmetric and incomplete information or illiquidity on the other hand. The approach is primarily analytical and based on structural models of dynamic portfolio choice. Since the focus is ultimately applied, this dissertation contains both theoretical and empirical results. ❧ In the first chapter I characterize analytically the investment policy of money managers with superior investment ability when fund flows are a convex function of end-of-period performance relative to peers. I show that skilled managers adopt contrarian strategies with respect to peers early in the period until a desired outperformance margin is achieved. Thereafter, they hedge against relative underperformance by investing like the herd. Convex fund flows may then induce excessive risk-taking in certain circumstances but excessive conservatism on average, leading the best managers to look like average performers. More generally, small differences in the flow-performance relationship can result in substantially different average risk-taking (herd vs. contrarian) behavior and return profiles by identically skilled managers. I argue that traditional measures may fail to adjust fund performance for the type of risks these managers take. Using a sample of top performers in the US mutual fund industry I present evidence supporting the model-implied relation between funds' herd/contrarian behavior and their flow-performance relationships. ❧ The second chapter is joint work with Luis Goncalves-Pinto. It looks into the effects on portfolio delegation of the additional incentive misalignments between delegating households and mutual fund managers that may appear when funds belong to a family organization like Vanguard or Fidelity. We focus on the possibility that family-affiliated funds cross their trades of illiquid common holdings in response to the interests of the family as a whole, and investors' flows are a convex function of relative returns. In such situations, we argue that fund families can play favorites among their members by having some funds reduce the costs of illiquidity while making others adopt suboptimal investment decisions. This effect makes the asset allocation decision of family-affiliated funds substantially different from that of standalone counterparts, a feature that has been neglected by the literature on portfolio delegation so far. By including this feature in our framework, we find that families' ability to cross-trade among member funds allows them to save on transaction costs but at the same time elicits higher risk-taking by affiliated fund managers compared to identical standalone funds. We further find that the additional costs of agency that investors incur under a fund family arrangement are likely to increase with asset liquidity. Our study has potential normative implications, as we show that investors can be better off in general when imposing position limits on their funds' portfolios. ❧ In the third chapter, I study the optimal design of compensation fees for a money manager when both she and delegating households face incomplete information about asset returns, but the manager has access to private information. This informational asymmetry is a potential source of value from delegation, and households' objective it to induce the manager to use her superior information in their best interest. The analysis focuses on the typical contracts observed in the industry, which include a proportional asset-based fee and benchmark-linked incentive fees of two types: (i) a linear (""fulcrum"") fee, and (ii) a convex (""option-like"") fee. I provide closed-form solution for the manager's optimal dynamic asset allocation over a fixed investment horizon when she learns asset fundamentals over time, and analyze numerically the contract that maximizes households' utility from delegation. In contrast to prior literature, I show that simple benchmarking rules are highly valuable in allowing households to exploit manager's superior information in their favor. When the manager's risk-tolerance differs from households', the optimal contract---within this class---is linear and always includes a benchmark-linked fulcrum fee. In order to offset insufficient or excessive risk-taking by the manager, the optimal benchmark has either a much higher or a much lower risk exposure than the unconditionally efficient portfolio the uninformed households would choose under self-management. I further show that option-like fees dominate pure proportional asset-based fees when the manager is more risk-averse than households. The optimality of benchmarked-linked fulcrum fees is robust to different precisions in manager's information and to different investment horizons. |
| Keyword | portfolio delegation; mutual funds; incomplete information; fund flows; herding; performance evaluation; liquidity; mutual fund families; internal capital markets; cross-trading; portfolio constraints; risk-taking incentives; benchmarking; management fees; optimal contracting. |
| Language | English |
| Part of collection | University of Southern California dissertations and theses |
| Publisher (of the original version) | University of Southern California |
| Place of publication (of the original version) | Los Angeles, California |
| Publisher (of the digital version) | University of Southern California. Libraries |
| Provenance | Electronically uploaded by the author |
| Type | texts |
| Legacy record ID | usctheses-m |
| Rights | Sotes-Paladino, Juan Martín |
| Access conditions | The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the author, as the original true and official version of the work, but does not grant the reader permission to use the work if the desired use is covered by copyright. It is the author, as rights holder, who must provide use permission if such use is covered by copyright. The original signature page accompanying the original submission of the work to the USC Libraries is retained by the USC Libraries and a copy of it may be obtained by authorized requesters contacting the repository e-mail address given. |
| Repository name | University of Southern California Digital Library |
| Repository address | USC Digital Library, University of Southern California, University Park Campus MC 7002, 106 University Village, Los Angeles, California 90089-7002, USA |
| Repository email | cisadmin@usc.edu |
| Archival file | uscthesesreloadpub_Volume4/etd-SotesPalad-667.pdf |
Description
| Title | Page 1 |
| Full text | ESSAYS ON DELEGATED PORTFOLIO MANAGEMENT UNDER MARKET IMPERFECTIONS by Juan Mart n Sotes-Paladino A Dissertation Presented to the FACULTY OF THE USC GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Ful llment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (BUSINESS ADMINISTRATION) May 2012 Copyright 2012 Juan Mart n Sotes-Paladino |
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