Investors’ Expectations, Management Fees and the Underperformance of Mutual Funds

60 Pages Posted: 6 Feb 2012  

Andreas D. Huesler

ETH Zürich

Yannick Malevergne

Université Paris I Panthéon-Sorbonne - Laboratoire PRISM

Didier Sornette

Swiss Finance Institute; ETH Zürich - Department of Management, Technology, and Economics (D-MTEC)

Date Written: February 3, 2012

Abstract

Why do investors keep buying underperforming mutual funds? To address this issue, we develop a one-period principal-agent model with a representative investor and a fund manager in an asymmetric information framework. This model shows that the investor’s perception of the fund plays the key role in the fund’s fee-setting mechanism. Using a simple relation between fees and funds’ performance, empirical evidence suggests that most US domestic equity mutual funds have added high markups during the period from July 2003 to March 2007. For these fees to be justified, we show that the investor would have expected the fund manager to deliver an overall annual net excess-return of around 1.5% the S&P 500 on a risk adjusted basis. In addition, our model offers a new classification of funds, based on their ability to provide benefits to investors’ portfolios.

Keywords: Mutual Fund Fee, Mutual Fund, Asymmetric Information, Principal-Agent Relationship, Markup

JEL Classification: G23, G11, D82

Suggested Citation

Huesler, Andreas D. and Malevergne, Yannick and Sornette, Didier, Investors’ Expectations, Management Fees and the Underperformance of Mutual Funds (February 3, 2012). Swiss Finance Institute Research Paper No. 12-01. Available at SSRN: https://ssrn.com/abstract=1998823 or http://dx.doi.org/10.2139/ssrn.1998823

Andreas D. Huesler

ETH Zürich ( email )

Zürichbergstrasse 18
8092 Zurich, CH-1015
Switzerland

Yannick Malevergne

Université Paris I Panthéon-Sorbonne - Laboratoire PRISM ( email )

17 rue de la Sorbonne
Paris, 75005
France

Didier Sornette (Contact Author)

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

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