Survival, Tournament, and Asset Allocation Strategy in the Mutual Fund Industry

Abstract

I present a model that characterizes the impact of relative performance compensation and replacement schemes on mutual fund managers' asset allocation decisions. The model provides explanations of the following questions: (1) why does fund risk manipulation concentrate in the latter part of an annual assessment period; (2) why do departing fund managers, on average, exhibit higher portfolio turnover rates and higher expenses relative to non-replaced fund managers; and (3) why do mutual funds have a significant preference toward stocks with low transaction costs and an aversion to stocks with low idiosyncratic volatility.