Offsetting the Implicit Incentives: Benefits of Benchmarking in Money Management
24 Pages Posted: 18 Aug 2006 Last revised: 17 Dec 2007
Date Written: November 2007
Money managers are rewarded for increasing the value of assets under management. This gives a manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. The misaligned incentives create potentially significant deviations of the manager's policy from that desired by fund investors. In the context of a familiar continuous-time portfolio choice model, we demonstrate how a simple risk management practice that accounts for benchmarking can ameliorate the adverse effects of managerial incentives. Our results contrast with the conventional view that benchmarking a fund manager is not in the best interest of investors.
Keywords: Benchmarking, Fund Flows, Implicit Incentives, Risk Taking, Risk Management, Portfolio Choice
JEL Classification: G11, G20, D60, D81
Suggested Citation: Suggested Citation