Delegated Asset Management, Investment Mandates, and Capital Immobility
45 Pages Posted: 15 Mar 2009 Last revised: 31 May 2012
Date Written: May 8, 2012
This paper develops a model to explain the widely used investment mandates in the institutional asset management industry based on two insights: First, giving a manager more investment flexibility weakens the link between fund performance and his effort in the designated market, and thus increases agency cost. Second, the presence of outside assets with negatively skewed returns can further increase the agency cost if the manager is incentivized to pursue outside opportunities. These effects motivate narrow mandates and tight tracking error constraints to most fund managers except those with exceptional talents. Our model sheds light on capital immobility and market segmentation that are widely observed in financial markets, and highlights important effects of negatively skewed risk on institutional incentive structures.
Keywords: Institutional Frictions, Negatively Skewed Risk, Tracking Error Constraints, Market Segmentation
Suggested Citation: Suggested Citation