Mutual Fund Portfolio Choice in the Presence of Dynamic Flows

Abstract

We analyze the implications of dynamic flows on a mutual fund's portfolio decisions. In our model, myopic investors dynamically allocate capital between a riskless asset and an actively managed fund which charges fraction-of-fund fees. The presence of dynamic flows induces "flow hedging" portfolio distortions on the part of the fund, even though investors are myopic. Our model predicts a positive relationship between a fund's proportional fee rate and its volatility. This is a consequence of higher-fee funds holding more extreme equity positions. Although both the fund portfolio and investors' trading strategies depend on the proportional fee rate, the equilibrium value functions do not. Finally, we show that our results hold even if investors are allowed to directly trade some of the risky securities.

Delegated portfolio management, optimal fee contracts, and asset prices

“…Overall, Lemma 4.4 is in line with Hugonnier and Kaniel (2010), who find (1) a positive relation between a fund's proportional fee rate and its leverage and (2) a negative relation between the fee rate and the investor's holding of the fund. Moreover, Lemma 4.4 implies that the fund's stock holding for each investor, θ(R t )X(R t ), is independent of φ (given R t ) because the positive effect of φ on θ(·) and its negative effect on X(·) just offset each other.…”

Portfolio selection of a closed-end mutual fund

“…For simplicity, we only discuss the closed-end fund in this paper. For the study of open-end fund, see Hugonnier and Kaniel (2010). In the following, we model the wealth process of a closed-end fund and its management fee structure.…”

“…Management fee structure, or fund manager's compensation scheme, is one of the most important factors that impact on the fund manager's decisions, and has bee studied widely and deeply in recent years. Fraction of funds fee, a type of symmetric ("fulcrum") fee, has been studied in Hugonnier and Kaniel (2010), which is a special case of our model. Papers that analyze asymmetric performance fees include Grinblatt and Titman (1989), Carpenter (2000) among others.…”

“…Literatures on the topic of optimal contract include Starks (1987), Ou-Yang (2003), Sung (2005), Cvitanic et al (2006) and Chang (2010) among others. For open-end funds, see Hugonnier and Kaniel (2010).…”

Principal-Agent Problems with Exit Options

“…Their framework was extended by Schättler andSung (1993, 1997), Sung (1995Sung ( , 1997, Detemple, Govindaraj, and Loewenstein (2001). See also Dybvig, Farnsworth and Carpenter (2001), Hugonnier, J. and R. Kaniel (2001), Müller (1998Müller ( , 2000, and Hellwig and Schmidt (2003). The papers Williams (2004) and Cvitanić, Wan and Zhang (2008) (henceforth CWZ 2008), use the stochastic maximum principle and Forward-Backward Stochastic Differential Equations (FBSDEs) to characterize the optimal compensation for more general utility functions, under moral hazard.…”