Domingues, Gabriela Bertol
(2012)
Essays on incentives and risk-taking in the fund industry.
PhD thesis, London School of Economics and Political Science.
Abstract
The first paper of this thesis uses a unique data set to assess the determinants of inflows and outflows in the fund industry. The higher frequency of the data allows to examine whether recent past performance affects the flow-performance relation. I find that the latter is concave for the worst-performing funds and convex for the best-performing funds. This is in stark contrast to previous studies in the literature that document a strict convex relationship. The disaggregation by inflows and outflows further indicates that the concavity is mainly due to outflows, which react much quicker to bad performance than previously assumed, whereas the convexity is driven by inflows. Finally, I also compare how the type of client affects the flow- performance relationship. I show that investors deemed less sophisticated care more about short-term performance than other investors, and more about raw returns than
risk-adjusted returns.
The second paper investigates how funds shift risk as a function of past performance. In contrast to the literature, I manage to disentangle the implicit incentive generated by the flow-performance relationship from the direct incentive generated by the portfolio manager remuneration contract. Identification is only possible because I focus on funds that pay bonus every six months instead of every year. I show not only that contracts have an asymmetric effect on risk, but also that the tournament within the fund family is the main driver of risk shifting. This is consistent with families actively engaging in the tournament by transferring not only performance, as suggested by the literature, but also risk from their worst- to their best-performing funds.
The last paper is joint with Pedro A. Saffi and uses a data set of Brazilian hedge funds holdings to examine the impact of long and short positions on performance. In particular, we test if changes in long/short positions and their risk can forecast future performance. While we find that funds with large increases in the risk of long-only positions risk relative to the previous 24 months underperform by about 3% per year on average, those that increase the risk of short-only positions overperform their peers by about 1% a year on average, net of fees. Neither monthly changes of long nor short positions can forecast next month’s abnormal returns.
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