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Herding and delegated portfolio management: Impact of relative performance on asset allocation

Journal

Quarterly Journal of Finance

Subject

Finance

Authors / Editors

Naik N Y;Maug E

Biographies

Publication Year

2011

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.

Available on ECCH

No


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