Paying for Beta: Embedded Leverage and Asset Management Fees
44 Pages Posted: 25 Oct 2019 Last revised: 2 Nov 2019
Date Written: October 15, 2019
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: Suggested Citation