Outsourcing vs. Integration in the Mutual Fund Industry: An Incomplete Contracting Perspective

44 Pages Posted: 22 Feb 2014

See all articles by Peter Marcel Debaere

Peter Marcel Debaere

University of Virginia - Darden School of Business; Centre for Economic Policy Research (CEPR)

Richard B. Evans

University of Virginia - Darden School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 20, 2014

Abstract

With detailed product- and firm-level data for mutual funds, we study why mutual fund families relinquish control of fund management (advising) and outsource to non-affiliated entities and why those entities agree to manage for the fund family. Fund families and fund advisors cannot write enforceable contracts over the return earned by the fund (task of the advisor) and the size of the fund to be raised (task of the fund family). Our empirics confirm key tenets of the incomplete contracting view of the firm’s boundaries. Expertise drives the fund family’s decision to manage funds internally or not. The closer the fund is to its core expertise, the more critical the fund family is for the operation of the fund, and the more likely the fund is managed internally. Access to investors drives the advisor’s decision to manage assets for an unaffiliated fund family. Consistent with sharing marginal revenue under outsourcing, outsourced funds on average are smaller and also have lower returns than internally managed funds. At the same time, from the perspective of the fund family and the advisor, once the selection bias of the family of fund’s decision to outsource and the advisor’s decision to agree to that outsourced arrangement are controlled for, the difference in size and returns between internally and externally managed funds disappear. In other words, because of their lack of expertise, the fund family would not be able to earn a higher return by managing the outsourced funds internally and because of their lack of access to investors, the advisor could not raise a larger fund.

Keywords: Incomplete Contracts, Oursourcing, Investment Advisor, Mutual Fund, Subadvisor

JEL Classification: D21, D23, D52, G23, L22,

Suggested Citation

Debaere, Peter Marcel and Evans, Richard B., Outsourcing vs. Integration in the Mutual Fund Industry: An Incomplete Contracting Perspective (February 20, 2014). Darden Business School Working Paper No. 2399177. Available at SSRN: https://ssrn.com/abstract=2399177 or http://dx.doi.org/10.2139/ssrn.2399177

Peter Marcel Debaere

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

HOME PAGE: http://www.darden.virginia.edu/html/direc_detail.aspx?styleid=2&id=5794

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Richard B. Evans (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4030 (Phone)
434-243-7680 (Fax)

HOME PAGE: http://faculty.darden.virginia.edu/evansr/

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