Investors’ Misperception: A Hidden Source of High Markups in the Mutual Fund Industry

Shengsui Hu (), Yannick Malevergne and Didier Sornette
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Didier Sornette: ETH Zurich and Swiss Finance Institute

No 09-04, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We develop a principal-agent model based on a sequential game played by a representative investor and a fund manager in an asymmetric information framework. The model shows that investors’ perceptions of the fund market play the key role in the fund’s fee-setting mechanism. The managers’ true ability to deliver performance is not relevant. Along with a simple relation between fees and funds’ performance, empirical evidence suggests that most U.S. domestic equity mutual funds have added high markups in recent years. We show that, for these fees to be justified, investors would have expected the fund managers to be able to deliver an overall annual excess-return of around 3% over the S&P 500, net of fees, irrespective of the investment style and of the risk level of the funds. Therefore, we interpret these high markups as resulting from the investors’ optimism bias whose root can be found in their lack of financial literacy as well as in funds’ marketing effort.

Keywords: Mutual Fund Fees; Mutual Funds; Asymmetric Information; Principal-Agent Relationships; Markup; Optimism Bias (search for similar items in EconPapers)
JEL-codes: D82 G11 G23 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2009-01
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0904

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