Delegated Portfolio Management, Benchmarking, and the Effects on Financial Markets
IMF Working Papers, September 8, 2015
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- Delegated Portfolio Management, Benchmarking, and the Effects on Financial Markets
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Bibliographic details
- Authors: Deniz O Igan, Marcelo Pinheiro
- Published: September 8, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513586878.001
Summary of scope and approach
- Analyzes implications of linking fund managers' compensation to the return of their portfolio relative to a benchmark (relative-performance-based objectives).
- Investigates effects in single- and multiple-asset/market frameworks.
- Considers cases with costly information acquisition and the resulting equilibrium effects.
Key findings
- Relative-performance-based objectives reduce investors' expected utility.
- Markets are typically more informative and deeper when managers are benchmarked.
- In a multiple asset/market framework:
- Relative performance concerns lead to an increase in the correlation between markets (financial contagion).
- Benchmark inclusion increases price volatility.
- Home bias emerges as a rational outcome.
- When information is costly:
- Information acquisition is hindered.
- This attenuation reduces the effects on market informativeness and depth.
Policy-relevant implications and conceptual takeaways
- Benchmarking of fund managers can improve market informativeness and depth but at the cost of investors' expected utility.
- Benchmark-linked compensation creates incentives that can raise systemic linkages across markets (higher cross-market correlation), elevating potential for financial contagion.
- Inclusion in benchmarks can amplify price volatility, suggesting trade-offs between transparency/information aggregation and market stability.
- Costly information environments weaken the beneficial market effects of benchmarking by discouraging information acquisition.
- Home bias can be rationalized within models where relative performance matters, implying that policies aiming to reduce home bias should consider incentive structures of delegated managers.
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