A Unified Theory of Delegated Capital Management

Jonathan B. Berk and Peter DeMarzo

No 34628, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a unified theory of delegated capital management by extending the paradigm of Berk and Green (2004) from mutual funds to alternative assets. With competitive markets and rational investors, we derive the optimal contract and account for observed regularities --- performance fees, persistent alpha, and limits on capital. The key distinction between mutual funds and alternatives is the liquidity of the underlying assets. When assets are illiquid, it is optimal to acquire information about the manager's skill. A positive alpha is therefore necessary to compensate informed investors and a performance based contract is required to induce these investors to allocate their capital optimally. At the same time, a free-rider problem emerges that requires capital constraints on uninformed investors. Thus, liquidity of the underlying assets explains the contrasting contract structures across sectors.

JEL-codes: G11 G14 G2 G20 G23 G24 G29 (search for similar items in EconPapers)
Date: 2026-01
Note: AP CF
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