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The Strategic Implementation of an Investment Process in a Funds Management Firm

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Abstract

One of several important strategic decisions that have to be made by an active funds management organization is how aggressively it implements its investment process. In this paper we model this decision on the assumption that the organization’s objective is to maximise the present value of its future fee income. We then develop the model using numerical methods in order to demonstrate the impact of several endogenous and exogenous factors on this optimum active position. In particular we highlight that the most aggressive funds are likely to be embryonic funds that have the greatest potential to add value. We also establish that in the event that such funds increase their funds under management; it will be optimum for them to become more index-like. We demonstrate that the extent to which the implementation decision for the active process is a function of a number of factors including the alpha and risk characteristics of the active component of the portfolio, the risk tolerance of the promoting organization and the relationship between performance and future fund flows. Our findings have extensive implications ranging from the choice of investment managers by investors to the functioning of capital markets.

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Bibliographic Info

Paper provided by The Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology, Sydney in its series Working Paper Series with number 17.

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Length: 24 pages
Date of creation: 01 Sep 2012
Date of revision:
Handle: RePEc:uts:pwcwps:17

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  1. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
  2. Lucia Milone & Paolo Pellizzari, 2009. "Mutual funds flows and the "Sheriff of Nottingham" effect," Working Papers 188, Department of Applied Mathematics, Università Ca' Foscari Venezia.
  3. Richard B. Evans, 2010. "Mutual Fund Incubation," Journal of Finance, American Finance Association, vol. 65(4), pages 1581-1611, 08.
  4. Diane Del Guercio & Paula A. Tkac, 2001. "Star power: the effect of Morningstar ratings on mutual fund flows," Working Paper 2001-15, Federal Reserve Bank of Atlanta.
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Cited by:
  1. Danny Yeung & Paolo Pellizzari & Ron Bird & Sazali Abidin, 2012. "Diversification Versus Concentration ......... and the Winner Is?," Working Paper Series 18, The Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology, Sydney.

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