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Investors’ Expectations, Management Fees and the Underperformance of Mutual Funds

Author

Listed:
  • Andreas D. Huesler

    (ETH Zürich)

  • Yannick Malevergne

    (University of Saint Etienne)

  • Didier Sornette

    (Swiss Finance Institute and ETH Zürich)

Abstract

Why do investors keep buying underperforming mutual funds? To address this issue, we develop a one-period principal-agent model with a representative investor and a fund manager in an asymmetric information framework. This model shows that the investor’s perception of the fund plays the key role in the fund’s fee-setting mechanism. Using a simple relation between fees and funds’ performance, empirical evidence suggests that most US domestic equity mutual funds have added high markups during the period from July 2003 to March 2007. For these fees to be justified, we show that the investor would have expected the fund manager to deliver an overall annual net excess-return of around 1.5% the S&P 500 on a risk adjusted basis. In addition, our model offers a new classification of funds, based on their ability to provide benefits to investors’ portfolios.

Suggested Citation

  • Andreas D. Huesler & Yannick Malevergne & Didier Sornette, 2012. "Investors’ Expectations, Management Fees and the Underperformance of Mutual Funds," Swiss Finance Institute Research Paper Series 12-01, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1201
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    File URL: http://ssrn.com/abstract=1998823
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    Cited by:

    1. Paulo Matos & Guilherme Padilha & Maurício Benegas, 2016. "On the management efficiency of Brazilian stock mutual funds," Operational Research, Springer, vol. 16(3), pages 365-399, October.

    More about this item

    Keywords

    Mutual Fund Fee; Mutual Fund; Asymmetric Information; Principal-Agent Relationship; Markup;
    All these keywords.

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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