Herding and Delegated Portfolio Management: The Impact of Relative Performance Evaluation on Asset Allocation

IFA Working Paper 223-1996

41 Pages Posted: 19 May 1998 Last revised: 19 Dec 2013

See all articles by Ernst G. Maug

Ernst G. Maug

University of Mannheim Business School; European Corporate Governance Institute (ECGI)

Narayan Y. Naik

London Business School - Institute of Finance and Accounting

Date Written: December 22, 1995

Abstract

This paper investigates the effect of fund managers' performance evaluation on their asset allocation decisions. We derive optimal contracts for delegated portfolio management and show that they always contain relative performance elements. We then show that this biases fund managers to deviate from return-maximising portfolio allocations and follow those of their benchmark (herding). In many cases the trustees of the fund who employ the fund manager prefer such a policy. We also show that fund managers in some situations ignore their own superior information and "go with the flow" in order to reduce deviations from their benchmark. We conclude that incentive provisions for portfolio managers are an important factor in their asset allocation decisions.

JEL Classification: G11, G20, G23

Suggested Citation

Maug, Ernst G. and Naik, Narayan Y., Herding and Delegated Portfolio Management: The Impact of Relative Performance Evaluation on Asset Allocation (December 22, 1995). IFA Working Paper 223-1996. Available at SSRN: https://ssrn.com/abstract=7362 or http://dx.doi.org/10.2139/ssrn.7362

Ernst G. Maug (Contact Author)

University of Mannheim Business School ( email )

L9, 1-2
Mannheim, 68131
Germany
+49 621 181-1952 (Phone)

HOME PAGE: http://cf.bwl.uni-mannheim.de/de/people/maug/

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Narayan Y. Naik

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 724 3317 (Fax)

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