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Are fund managers incentivised to ignore stock market jumps?

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  • Ilias Chondrogiannis
  • Mark Freeman
  • Andrew Vivian

Abstract

In this paper, we show that the way in which fund managers are compensated can, under plausible conditions, lead them to act in a way that does not maximise the wellbeing of their clients. Due to performance bonuses in fund managers' rewards, there is a highly non-linear relationship between the wealth of the client and the fees that the manager receives. We demonstrate that jumps in equity returns can lead to a conflict of interest between the investor and the manager in such a setting. Specifically, the managers' option-type payment structure can incentivise them to not account for the downside risk induced by jumps, especially if the fund manager is only in post for a few years; thus managers may pursue a more aggressive asset allocation strategy than their clients desire. Our key policy recommendation is that regulators should consider imposing a negative fund fee in times of very poor absolute fund performance to mitigate against suboptimal fund management asset allocation decisions.

Suggested Citation

  • Ilias Chondrogiannis & Mark Freeman & Andrew Vivian, 2023. "Are fund managers incentivised to ignore stock market jumps?," The European Journal of Finance, Taylor & Francis Journals, vol. 29(15), pages 1793-1823, October.
    • Handle: RePEc:taf:eurjfi:v:29:y:2023:i:15:p:1793-1823
    DOI: 10.1080/1351847X.2022.2156804
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