Herding and Delegated Portfolio Management: The Impact of Relative Performance Evaluation on Asset Allocation
IFA Working Paper 223-1996
41 Pages Posted: 19 May 1998 Last revised: 19 Dec 2013
Date Written: December 22, 1995
This paper investigates the effect of fund managers' performance evaluation on their asset allocation decisions. We derive optimal contracts for delegated portfolio management and show that they always contain relative performance elements. We then show that this biases fund managers to deviate from return-maximising portfolio allocations and follow those of their benchmark (herding). In many cases the trustees of the fund who employ the fund manager prefer such a policy. We also show that fund managers in some situations ignore their own superior information and "go with the flow" in order to reduce deviations from their benchmark. We conclude that incentive provisions for portfolio managers are an important factor in their asset allocation decisions.
JEL Classification: G11, G20, G23
Suggested Citation: Suggested Citation