Peer versus Pure Benchmarks in the Compensation of Mutual Fund Managers
39 Pages Posted: 24 Aug 2019 Last revised: 25 Nov 2019
Date Written: November 18, 2019
We examine the role of peer (e.g., Lipper indices) vs. pure (i.e., market indices) benchmarks in the compensation contract of mutual fund managers using a unique hand-collected dataset. We find that 21% (29%) of our sample funds report their managers’ compensation based only on a peer (pure) benchmark, with the remaining portfolio managers compensated based on a combination of both. On the contrary to the perception of both regulators and academics, we find peer benchmarks are more difficult to beat compared to pure benchmarks. Funds with peer-benchmark compensated managers charge higher fees, but still outperform on a risk-adjusted net performance basis. Pure-benchmark compensated managers, on the other hand, exhibit lower active share and tracking error, as well as higher R-squared, consistent with less effort or ability. Lastly, managers compensated with peer benchmarks tend to work for funds that have more sophisticated investors and families with stronger incentives for internal competition. Overall, these results are consistent with market segmentation playing a role in the difference between peer and pure benchmarked compensation contracts.
Keywords: mutual funds, fund manager, managerial compensation, incentives, benchmarking, peer benchmarks, closet indexing
JEL Classification: G11, G23, J33, J44
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