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Are fund managers rewarded for taking cyclical risks?

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  • Ryan, Ellen

Abstract

The investment fund sector has expanded dramatically since the crisis of 2008-2009. As the sector grows, so do the implications of its risk-taking for the wider financial system and real economy. This paper provides empirical evidence for the existence of wide- spread risk-taking incentives in the investment fund sector, with a particular focus on incentives for synchronised, cyclical risk-taking which could have systemic effects. Incentives arise from the positive response of investors to returns achieved through cyclical risk-taking and non-linearities in the relationship between fund returns and fund flows, which may keep managers from fully internalising the effects of adverse outcomes on their portfolios. The fact that market discipline may not be sufficient to ensure prudential behaviour among managers, combined with the externalities of this risk-taking for the wider system, creates a clear case for macroprudential regulatory intervention. JEL Classification: G23, G11, G28

Suggested Citation

  • Ryan, Ellen, 2022. "Are fund managers rewarded for taking cyclical risks?," ESRB Working Paper Series 134, European Systemic Risk Board.
    • Handle: RePEc:srk:srkwps:2022134
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    File URL: https://www.esrb.europa.eu//pub/pdf/wp/esrb.wp134~292c32eb7e.en.pdf
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    References listed on IDEAS

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    Cited by:

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    2. Milan Szabo, 2023. "Cyclical Investment Behavior of Investment Funds: Its Heterogeneity and Drivers," Working Papers 2023/5, Czech National Bank.

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    More about this item

    Keywords

    Financial stability; incentive; investment funds; risk-taking;
    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
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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