Dynamic Management of Mutual Fund Advisory Contracts

Doğuş University Journal; V.7-2 (2006) p.172-189

38 Pages Posted: 26 Apr 2006 Last revised: 7 Sep 2013

Date Written: April 20, 2006

Abstract

The price of professional portfolio management provided by the mutual fund adviser depends not only on the fund characteristics but also on the fund objective, the adviser's portfolio related and management based decisions, and the portfolio performance. We analyze the advisory fee, using a survivorship bias free data set of 176 equity funds managed by 125 different advisers. Advisers benchmark the objective average but this benefit the shareholders only when the objective trend is descending. Advisers tend to reduce the cost of their marginal product through the use of derivatives or manipulate by engaging in soft dollar agreements. We find that the advisers actively manage the advisory fee contracts responding to the outcome of their management decisions. The advisory fee increases after voluntary fee reimbursement or if the adviser is not fully reimbursed for the compensation of independent directors and officers. Risk taking behavior is the main motivation behind the structure of the advisory contracts. Advisers who adopt more linear contracts that would motivate them to take on more risk tend to use derivatives arguably for better risk management and are less likely to engage in research agreements that would require a reduction in the advisory fee.

Keywords: Mutual fund, Advisory fee, Management fee, Contract, Adviser

JEL Classification: G2, G3, L14

Suggested Citation

Erzurumlu, Yaman O. and Erzurumlu, Sinan, Dynamic Management of Mutual Fund Advisory Contracts (April 20, 2006). Doğuş University Journal; V.7-2 (2006) p.172-189, Available at SSRN: https://ssrn.com/abstract=898068 or http://dx.doi.org/10.2139/ssrn.898068

Yaman O. Erzurumlu (Contact Author)

George Mason University Korea ( email )

119 Songdomunhwa-ro, Yeonsu-gu, Incheon 21985
Incheon, 21985

Sinan Erzurumlu

Babson College ( email )

231 Forest St.
Babson Park, MA 02457-0310
United States

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