Asset Management Fees Research Articles

Smart Rebalancing

The sometimes vast gap between live results and paper portfolio performance is caused in part by trading costs, discontinuous trading, and missed trades or other frictions, along with asset management fees. Smart beta and factor strategies are not exempt from this sort of “implementation shortfall.” This paper provides new evidence on the efficacy of prioritizing transactions so as to focus portfolio turnover on the trades that offer the strongest signals and hence the highest potential performance impact. Rebalancing filters of this sort can capture much of the factor premia for a long-only paper portfolio while cutting turnover and trading costs relative to a fully rebalanced portfolio.

Paying for beta: Leverage demand and asset management fees

We examine how investor demand for leverage shapes asset management fees. We show that in the sample of U.S. equity mutual funds: (1) fees increase in fund market beta precisely for beta larger than one; (2) this relation becomes stronger and high-beta funds experience larger inflows when leverage constraints tighten; and (3) low net alphas are especially common among high-beta funds. These results are consistent with a model in which asset managers compete for leverage-constrained investors with heterogeneous risk aversion. The asymmetric relation between betas and fees also extends to the HML and SMB factors.

Paying for Beta: Embedded Leverage and Asset Management Fees

We examine how investor demand for leverage shapes asset management fees. In our model, investors' leverage demand generates a cross-section of positive fees even if all managers produce zero risk-adjusted returns. We find support for the model's novel predictions in the sample of the U.S. equity mutual funds: (1) fees increase in fund market beta precisely for beta larger than one; (2) this relation becomes stronger when leverage constraints tighten; and (3) low net alphas are especially common among high-beta funds. These results suggest that asset managers can earn fees above their risk-adjusted returns for providing their investors with leverage.

Closet Indexing: The Cost of Falling Asset Management Fees

In recent decades, investors have benefited from decreasing asset management fees and increasing availability of passive investment products. However, the practice of closet indexing, in which funds charge active management fees while closely mimicking a benchmark, has grown to include over 30% of mutual fund assets (Cremers and Petajisto 2009). We ask whether these trends are related, and develop a model to analyze how fees (in levels and types) affect funds' incentives to closet index. Building upon the notion that investors' flows compete away abnormal returns (Berk and Green 2004), our model endogenizes information production and closet indexing, and also decomposes fees into two components: passive fees for delegated portfolio management services and active fees for expected outperformance. Our analysis shows that lower passive fees lead to increased closet indexing and decreased information production. Rather than behaving as substitutes, where decreasing revenues from passive fees increase information production incentives, the two revenue sources are complementary. While investors benefit directly from decreasing costs of portfolio management, this result highlights an indirect cost: less active research may lead to less efficient prices. Furthermore, if given the ability to signal via a performance-based fee, high-skill funds forgo the option and only middle-skill funds adopt the signaling mechanism. This counter-intuitive result is driven by funds' desires to attract high AUM and high accompanying revenue from passive fees. For high-skill funds, relying on future performance to separate is less costly than charging performance-based fees, because retaining a portion of abnormal returns decreases AUM and rents from investors' passive fees.

Investment Mandates and the Downside of Precise Credit Ratings

We theoretically investigate the effect of public information — such as credit ratings and securities analysts’ reports — on investor welfare in the context of delegated asset management. Specifically, we ask: does more precise public information increase investor welfare by decreasing an asset manager’s informational advantage and, thereby, mitigating the agency problem between him and his client? We show, first, that public information does not align incentives and, second, that decreasing the precision of the information is Pareto improving. Interpreting public information as credit ratings, this suggests that widening ratings categories makes everyone better off. Our results are consistent with some empirical facts about asset management fees.

Lifetime Expected Income Breakeven Comparison between SPIAs and Managed Portfolios

This paper provides insight and guidance for the retiree decision making between whether to annuitize or manage their retirement savings. Tables and graphs demonstrate the breakeven age between annuitizing with a single premium immediate annuity (SPIA) versus managing a portfolio and the likelihood of outliving the breakeven cash flow sums for various annuitization ages (65 to 85), longevity percentiles of Period Life Tables, and portfolio allocations. What are breakeven asset allocations below which a SPIA provides a higher lifetime expected total cash flow? Managed portfolios retain a balance at death while SPIAs have none. How does the cash flow breakeven comparison change when that balance is, or is not, considered? Does age matter in the decision to switch from a managed portfolio to a SPIA? Is there a different conclusion if different tables are used (Social Security Table General Population vs Annuity 2000 Table (Healthy Population))? How do good vs median vs poor markets affect the breakeven comparison? How do fees affected the comparison? Can the Annual Payout Rate (APR) of a SPIA be useful in the decision making process? A more descriptive paper, without data Appendices and different figures, and fewer pages has been added to SSRN in abstract http://ssrn.com/abstract=2352252. This abstract http://ssrn.com/abstract=2317857 contains the data, figures and appendices that support the work described in more and better detail in http://ssrn.com/abstract=2352252, which also has a description for a practical application that is easier to do compared to the methodology used to produce that data in these two abstracts. Note: The cash flow in this paper is based on zero asset management fees, ½% fees or 1% fees. However, note that the fees are taken from the cash flow, not the portfolio balance, in this paper. This tilts the analysis in favor of SPIAs. Example: a 1% fee on a $500,000 portfolio would be $5000 for the year. If the cash flow for that year was calculated to be $25,000 (5% of portfolio value), then the net cash flow to the retiree would be $20,000 ($25k - $5k). However, if the portfolio itself pays the management fees, which is more common, then the $5,000 fee in this example would come from the $500,000, thus the cash flow calculation would be 5% on the $495,000 portfolio => $24,750 net to the retiree. Cash flow in this paper is based on the prior form, and thus biases the results towards SPIAs earlier than would normally be the case.

Illiquidity Risk in Non-Listed Funds: Evidence from REIT Fund Exits and Redemption Suspensions

Managerial incentives are skewed in non-listed funds under finite horizons. Compensation structures are only indirectly related to shareholder wealth maximization when share prices are unobservable. Liquidity options for investors are limited in the absence of an exchange listing. Using a hand-collected database for public non-listed REITs, an empirical sequence considers the impact of management compensation contracts on equity fundraising and success in capital deployment. Evidence is provided that high asset management fees and high acquisition fees diminish managerial success at generating revenue from invested capital. Successful revenue flows are deterministic factor in the level of distributions paid and the likelihood of achieving a fund exit. Closing the gate on share redemption plans is synchronized with the slowdown in new equity flows. Retail investors are insensitive to maligned compensation structures that heighten illiquidity risk, even when observable in the prospectus.

The Growth of Finance

The US financial services industry grew from 4.9 percent of GDP in 1980 to 7.9 percent of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly fees associated with residential mortgages. This expansion was fueled by the development of nonbank credit intermediation (or “shadow banking”). We offer a preliminary assessment of whether the growth of active asset management, household credit, and shadow banking—the main areas of growth in the financial sector—has been socially beneficial.

The Growth of Modern Finance

The U.S. financial services industry grew from 4.9% of GDP in 1980 to 7.9% of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly fees associated with residential mortgages. This expansion was itself fueled by the development of non-bank credit intermediation (or banking). We offer a preliminary assessment of whether the growth of active asset management, household credit, and shadow banking - the main areas of growth in the financial sector - has been socially beneficial.

Investment Banks and Their Affiliated Mutual Funds: International Evidence from IPO Allocations

We examine the way investment banks allocate IPOs to their affiliated mutual funds worldwide. An underwriter may allocate hot IPOs to its affiliated funds to improve fund performance and increase asset management fees. Alternatively, a bank may allocate to its affiliated mutual funds poorly-performing IPOs that would otherwise be undersubscribed, using affiliates as a “dumping ground” to preserve investment banking fees. We analyze IPO allocations to affiliates globally and find significant cross-country differences in the first-day returns of these IPOs. Although IPOs allocated to affiliated funds outside the U.S have significantly lower first-day returns, IPO allocations to all mutual funds — both affiliated and unaffiliated — in countries with strong investor protection tend to have higher first-day returns, benefiting fund investors. Furthermore, strong investor protection appears to discourage underwriters from allocating IPOs with negative first-day returns to their affiliates. Overall, the evidence suggests the presence of an economically significant conflict of interest within financial conglomerates for which prior literature has not found robust empirical support. Results also highlight the importance of effective investor protection in mitigating this conflict.

The Role of International Real Estate in Global Mixed-Asset Investment Portfolios

Executive Summary. Many studies have advocated the inclusion of real estate in mixed-asset investment portfolios. However, the majority of past studies have focused on the role of domestic real estate in domestic mixed-asset portfolios. This study goes further by considering whether the inclusion of international real estate would enhance the risk-return characteristics of an internationally diversified investment portfolio that already invests in bonds, cash, equities and gold. The study also corrects for the higher taxes, transaction costs and asset management fees incurred when investing in real estate vis-à-vis the other asset classes, as well as the impact of appraisal-smoothing on reported real estate returns. Using mean-variance portfolio optimization, the study concludes that, even after these corrections, international real estate does have a viable role to play in global mixed-asset investment portfolios.

Issues in Measuring Performance of Commingled Real Estate Funds

Executive Summary. This study analyzes the performance of non-securitized real estate investments in relation to two phenomena—the effect of asset management fees and the persistence of the returns. This is done using data from the Townsend Real Estate Universe on CREFs. Cumulative returns and Jensen's alpha are used for seventy-two CREFS. The NCREIF Index is used as the benchmark return. The results indicate that performance rankings are not effected by asset management fees and that the choice of a risk-adjusted performance measure (Jensen's alpha) or a non-risk-adjusted performance measure (the cumulative return) have a significant impact.