Anthony W. Lynch, David K Musto
ABSTRACT
This paper considers the economic role of fees in aligning the incentives
of money managers with those of investors. We examine a simple model in
which manager effort (or investment in human and physical capital) is observed
by the investor prior to her investment decision, but is not verifiable.
This setup creates a positive economic role for net asset value (NAV) as
a contracting variable and thus provides an explanation for the widespread
use of contracts based on NAV in both the mutual and hedge fund industries.
We also provide an explanation for why hedge funds use asymmetric performance
fees while mutual funds typically charge a fixed fraction of NAV (even
though 'fulcrum' performance fees are available).
Subject: Investments/Portfolio Choice (Theoretical)
Lynch: (212) 998-0350 alynch@stern.nyu.edu
Musto: (215) 898-4239 musto@wharton.upenn.edu
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