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On the Regulation of Fee Structures in Mutual Funds

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  • Sanjiv Ranjan Das
  • Rangarajan K. Sundaram

Abstract

We offer an alternative framework for the analysis of mutual funds and use it to examine the rationale behind existing regulations that require mutual fund advisor fees to be of the fulcrum' variety. We find little justification for the regulations. Indeed, we find that asymmetric incentive fees' in which the advisor receives a flat fee plus a bonus for exceeding a benchmark index provide Pareto-dominant outcomes with a lower level of equilibrium volatility. Our model also offers some insight into fee structures actually in use in the asset-management industry. We find that when leveraging is not permitted and the fee structure must be of the fulcrum variety, the equilibrium fee in our model is a flat fee with no performance component; if asymmetric incentive fees are allowed and leveraging is permitted the equilibrium fee is an incentive fee with a large performance component. These predictions match observed fee structures in the mutual fund industry and the hedge fund industry, respectively.

Suggested Citation

  • Sanjiv Ranjan Das & Rangarajan K. Sundaram, 1998. "On the Regulation of Fee Structures in Mutual Funds," NBER Working Papers 6639, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6639
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    Cited by:

    1. Sandeep Kapur & Allan Timmermann, 2005. "Relative Performance Evaluation Contracts and Asset Market Equilibrium," Economic Journal, Royal Economic Society, vol. 115(506), pages 1077-1102, October.
    2. Bank for International Settlements, 2003. "Incentive structures in institutional asset management and their implications for financial markets," CGFS Papers, Bank for International Settlements, number 21.
    3. Teresa Corzo Santamaría & Carlos Martinez de Ibarreta & Juan Rodriguez Calvo, 2018. "Timid performance fees in mutual funds," Journal of Asset Management, Palgrave Macmillan, vol. 19(1), pages 64-77, January.
    4. Juan-Pedro Gómez & Tridib Sharma, 2006. "Portfolio delegation under short-selling constraints," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(1), pages 173-196, May.
    5. Ana C. Díaz†Mendoza & Germán López†Espinosa & Miguel A. Martínez, 2014. "The Efficiency of Performance†Based Fee Funds," European Financial Management, European Financial Management Association, vol. 20(4), pages 825-855, September.
    6. Paul G. Mahoney, 2004. "Manager-Investor Conflicts in Mutual Funds," Journal of Economic Perspectives, American Economic Association, vol. 18(2), pages 161-182, Spring.
    7. Palomino, Frederic & Prat, Andrea, 2003. "Risk Taking and Optimal Contracts for Money Managers," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 113-137, Spring.
    8. Ping Hu & Jayant Kale & Ajay Subramanian, 2003. "Compensation, Career Concerns, and Relative Risk Choices by Mutual Fund Managers: Theory and Evidence," Levine's Bibliography 666156000000000349, UCLA Department of Economics.
    9. Igan, Deniz & Pinheiro, Marcelo, 2012. "The effects of relative performance objectives on financial markets," MPRA Paper 43452, University Library of Munich, Germany.
    10. Franklin R. Edward, 1999. "Hedge Funds and the Collapse of Long-Term Capital Management," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 189-210, Spring.
    11. Uday Rajan & Sanjay Srivastava, 2000. "Portfolio Delegation with Limited Liability," Econometric Society World Congress 2000 Contributed Papers 1503, Econometric Society.

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