Paying for Beta: Embedded Leverage and Asset Management Fees

44 Pages Posted: 25 Oct 2019 Last revised: 2 Nov 2019

See all articles by Steffen Hitzemann

Steffen Hitzemann

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Stanislav Sokolinski

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics

Mingzhu Tai

The University of Hong Kong - School of Economics and Finance

Date Written: October 15, 2019

Abstract

This article studies the effects of leverage constraints on asset management fees. We present a new model in which constrained investors delegate capital to asset managers. In the equilibrium, risk-seeking investors choose high beta managers who charge high fees for providing embedded leverage. Our empirical results in the sample of the U.S. equity mutual funds are consistent with the model's three novel predictions: 1) fees increase in market beta, but only when beta is larger than one, 2) this relation is stronger when leverage constraints tighten, and 3) fund net alpha declines in beta faster than its gross alpha. Our study suggests that willingness to pay for embedded leverage helps explain net-of-fees underperformance of actively managed funds.

Keywords: Leverage; Financial Intermediation; Mutual Funds

JEL Classification: G11; G23

Suggested Citation

Hitzemann, Steffen and Sokolinski, Stanislav and Tai, Mingzhu, Paying for Beta: Embedded Leverage and Asset Management Fees (October 15, 2019). Available at SSRN: https://ssrn.com/abstract=3470288 or http://dx.doi.org/10.2139/ssrn.3470288

Steffen Hitzemann

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Stanislav Sokolinski (Contact Author)

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics ( email )

111 Washington Avenue
Newark, NJ 07102
United States

Mingzhu Tai

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong

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