Sanjiv Ranjan Das, Rangarajan K. Sundaram
ABSTRACT
Existing regulations require fee structures used to compensate advisers in
the mutual fund industry to be the "fulcrum" variety, decreasing for
underperforming a given index in the same way in which they increase for
outperforming it. In this paper, we offer a new model for analysing the
mutual fund industry, and use this model to examine the impact of
restricting the fee structures that may be employed. We find little
justification for existing regulations. Indeed, we find that "incentive
fees" in which the advisor receives a flat fee plus a bonus for exceeding
a benchmark index provide Pareto-dominant outcomes with a lower level of
equilibrium volatility.
Our model also offers some insight into fee structures actually in use in
the asset-management industry. We find that when leveraging is not
permitted and a fulcrum fee must be employed, the equilibrium fee is a
flat fee with no performance component: while if incentive fees are
allowed and leveraging is permitted the equilibrium fee is an incentive
fee with large performance component. These results mesh well with
observed fee structures in the mutual fund industry and the hedge fund
industry, respectively.
Ranjan Das: Sds@hbs.edu
Saundaram:
Rsundara@stern.nyu.edu
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