Equilibrium Prices in the Presence of Delegated Portfolio Management

Abstract

This paper analyzes the asset pricing implications of commonly-used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio. The contract parameters, the extent of delegation and equilibrium prices are all determined endogenously within the model we consider. Symmetric ("fulcrum") performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the Sharpe ratios. Asymmetric performance fees have more complex effects on equilibrium prices and Sharpe ratios, with the signs of these effects fluctuating stochastically over time in response to variations in the funds’ excess performance.

Keywords: delegation, equilibrium, fund, portfolio

JEL Classification: D40, D50, G11, G12, G20