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Competition in the Mutual Fund Industry: Evidence and Implications for Policy
Abstract
Since 1960 the mutual fund industry has grown from 160 funds and $18 billion in assets under management to over 8,000 funds with $10.4 trillion in assets. Yet critics- including Yale Chief Investment Officer David Swensen, Vanguard founder Jack Bogle, and New York Governor Eliot Spitzer - call for more fund regulation, claiming that competition has not protected investors from excessive fees. Starting in 2003, the number of class action suits against fund advisors increased sharply, and, consistent with critics' views, some courts have excluded or treated skeptically evidence of competition and comparable fees of other funds. Skepticism about fund competition dates to the 1960s, when the SEC accepted the view that market forces fail to constrain advisory fees, in part because fund boards rarely fire advisors. In this article, we show that economic theory, empirical evidence, and careful analysis of the laws and institutions that shape mutual funds refute this view. Fund critics overlook the most salient characteristic of a mutual fund: redeemable shares. While boards rarely fire advisors, fund investors may 'fire' advisors at any time by redeeming shares and switching into other investments. Industry concentration is low, new entry is common, barriers to entry are low, and empirical studies - including new evidence presented in this article - show higher advisory fees significantly reduce fund market shares, and so constrain fees. Fund performance is consistent with competition exerting a strong disciplinary force on funds and fees. Our findings lead us to reject the critics' views in favor of the legal framework established by §36(b) of the Investment Company Act and the lead case interpreting that law (the Gartenberg decision), while suggesting Gartenberg is best interpreted to allow the introduction of evidence regarding competition between funds.
... Since fund fees are set by fund management companies themselves, one would assume that fund fees would decrease with the level of competition. Coates and Hubbard (2007) argue that "the mutual fund industry is a classic, competitively structured industry, with hundreds of competing firms offering thousands of products, low barriers to entry and firm expansion, and low concentration". Various reports from the Investment Company Institute ((2010), (2014) etc.) emphasize that fund expense ratios are continuously decreasing and the economy of scale from the huge recent growth in the assets under management is being passed on to small investors. ...
... Our paper contributes to the literature in several aspects. First, to the best of our knowledge, it is the first paper to establish a direct link between market competition and mutual fund fees and thus adds to a growing literature on fund market competition (Coates and Hubbard (2007), Freeman and Brown (2001), Murphy (2005), Pastor, Stambaugh and Taylor (2015) etc.). Furthermore, by suggesting that market competition on its own may not be sufficient to decrease funds fees, our study has important policy implications that regulatory interventions targeted at encouraging competition or lowering entry barriers may not be able to bring down the fund fees; whereas interventions targeted at making small investors more aware of the fund fees may help as it will make them more sensitive towards net performance of asset management funds. ...
... Consistent with the view that competition is not sufficient to drive down mutual fund fees (United States General Accounting office (2003)) and contrary to Coates and Hubbard (2007), the positive coefficient on Competition is economically and statistically significant (at the 1% level). We replace the continuous Competition measure with a dummy variable, High Comp, which equals 1 when a Lipper class's Competition is in the top half of the sample, and 0 otherwise. ...
We find a puzzling fact about mutual fund industry that funds operating in more competitive segments charge higher fees. We argue that this surprising positive relation between competition and fund fees is consistent with strategic fee setting by funds. Fund performance is better and more persistent in less competitive segments, which attracts relatively more performance-sensitive investors. This leaves relatively less performance-sensitive investors in more competitive markets. Hence, funds operating in more competitive markets face a relatively inelastic demand curve and take advantage of it by increasing their fees (which reduces investors' net returns). Our findings have important policy implications that market competition on its own may not be sufficient to decrease fund fees and regulatory interventions are required to increase investor awareness of mutual fund fees and their adverse impacts on net fund performance.
... The ability of open end mutual fund investors to buy or sell shares at net asset value promotes competition among funds since investors can evaluate fees and switch to other funds at a relatively low cost. Coates and Hubbard (2007) argue that competitive forces in the mutual fund industry causes investment advisors to charge fees that are in line with the services offered in the long run as investors move to lower cost, higher-service, and higher-return investments. ...
... The insignificant board results for single share class funds presented in models 1 through 3 are consistent with Coates and Hubbard's (2007) argument that competition among funds for cash flows mitigates agency problems and constrains manager's fees by aligning sponsor and mutual fund investor interests. For multiple share class funds, however, where we expect increased agency costs, the results indicate that competition alone does not eliminate the role of boards in fee negotiations. ...
... Although not reported, we also examine front end loads and deferred sales charges and find a similar pattern. Fee spreads exhibit the same pattern but with larger increases occurring after the year 2002, coinciding with a dramatic increase in the number of lawsuits accusing mutual fund sponsors of charging excessive fees(Coates and Hubbard, 2007). The results indicate that despite periods of fluctuating financial markets, mutual fund fees continue to grow for fund and sponsor fund families.Panel C describes the correlations among the variables in the sample. ...
There is a long running debate over whether a portion of the fees that investment advisory firms charge are disproportionate or "excessive" relative to the services they provide. We examine this issue using a comprehensive sample of index mutual funds covering the period from 1998 to 2007. We posit that excessive fees are prevalent in funds with multiple share classes and those with weak governance structures. Consistent with this hypothesis, we find that (i) fee spreads, the range of fees charged to the lowest and highest cost share classes of the same fund, are positively related to the number of share classes offered (about 20 basis points per class), (ii) internal governance mechanisms only matter for funds with relatively small share classes where investors often face increased search costs and/or restricted access to competitive mutual funds, (iii) funds managed by public sponsors are associated with disproportionately higher fee spreads (about 9 basis points), and (iv) for a sample of funds with multiple classes, boards comprised exclusively of independent directors or those with fund sponsor officers are associated with lower fee spreads (about 11 basis points). Overall, our results indicate that competition and agency considerations are important determinants in the pricing of mutual funds.
... Evolving over the years and offering a wide variety of choices with a relatively easier entry for new players because of low barriers, the Indian mutual fund market concentration is low. ISSN: 2005-4238 IJAST Copyright ⓒ 2020 SERSC [3] This paper examines the concentration and competition of the Indian Mutual Fund Industry. It then dwells deeper by examining category-wise concentration to gain better insights. ...
... [12] while expense ratio and asset inflows have no relation at all! [13] However, some studies found that fund asset is negatively related to fees, and this dimension alone determines competition in the industry. [3] Another reason that motivates studying market share is that it determines the revenues of AMCs. After all, family size determines its profitability. ...
This paper examines the competitiveness and concentration of the Indian Mutual Fund Industry. The industry is the fastest-growing mutual fund market in the Asia-Pacific region, as witnessed from increased Assets Under Management (AUM) over the years. The already crowded mutual fund industry continues to attract newer financial institutions to start the AMC business, potentially making it to be more competitive in the future. This paper uses the Concentration Ratio (CR4) and the Herfindahl-Hirschman Index (HHI) models to measure the industry competitiveness for the period 2007-2020. Scheme category-level concentrationswere checked, probably the first such documentation in research circles. The study finds that the Indian mutual fund market is competitive and unconcentrated during the study period. Further, it is unconcentrated in equity, debt, and hybrid categories and moderately concentrated in other categories. Findings from this study can help AMC and financial engineers in better product design and positioning and for regulators before allowing entry of new players or mergers.
... The increasing number of funds signs for an increasing tight competition among mutual funds in attracting investors. Coates IV & Hubbard (2007) believe that competition among mutual funds is strong enough, that there is no need for fund regulations 3 to protect investors from excessive fees. Morley & Curtis (2007) agree with Coates IV & Hubbard (2007) but also suggest that boards would be a useful supplement to market competition. ...
... Coates IV & Hubbard (2007) believe that competition among mutual funds is strong enough, that there is no need for fund regulations 3 to protect investors from excessive fees. Morley & Curtis (2007) agree with Coates IV & Hubbard (2007) but also suggest that boards would be a useful supplement to market competition. ...
... On the other hand, the online automated advisors of both for-profit firms and firms selling their own investment plans are likely to be seen as the result of higher levels of expertise than those of not-for-profit firms and firms selling investment plans of others. Expertise is a competitive weapon that forprofit firms need to survive in highly sophisticated, tightly regulated, competitive markets such as those for investment plans (see e.g., Coates and Glenn Hubbard 2007). Not-forprofit firms simply do not face these challenging market rules and thus expertise is less of an issue. ...
... When it comes to perceptions of expertise, for-profit firms, much like pension plan providers, are seen as having higher levels of expertise than not-for-profit firms and independent intermediaries. This suggests, as we anticipated in our conceptualization, that without a high level of expertise these firms would have a hard time surviving in a highly sophisticated competitive market such as that for pension products (see e.g., Coates and Glenn Hubbard 2007). ...
Financial advisors seek to accurately measure individuals' risk preferences and provide sound personalized investment advice. Both advice tasks are increasingly offered through automated online technologies. Little is known, however, about what drives individuals' acceptance of such automated financial advice and, from a consumer point of view, which firms may be best positioned to provide such advice.
We generate novel insights on these questions by conducting a real-world empirical study using an interactive automated online tool that employs an innovative computer algorithm to build pension investment profiles, the “Pension Builder,” and a large, representative sample.
We focus on the role that two key firm characteristics have on consumer acceptance of pension investment advice generated by computer algorithms running on automated interactive online tools: profit orientation and role in the sales channel.
We find that consumers' perceptions of trust and expertise of the firm providing the automated advice are important drivers of advice acceptance (besides a strong impact of the satisfaction with the consumer–online tool interaction), and that these constructs themselves are clearly influenced by the for-profit vs. not-for-profit orientation and the product provider vs. advisor only role in the sales channel of the firm providing the advice.
We discuss the implications of our findings for marketers and policy makers and provide suggestions for future research.
This work is available at the publisher through open access
... We now turn to the literature on competition between fund managers with AUM-based fees. Coates and Hubbard (2007) argue that fierce competition exerts a strong disciplinary force on mutual funds, thereby reducing the need for legal intervention to prevent funds from charging excessive fees. Morley and Curtis (2010) claim that competition can substitute for both governance regulation and litigation. ...
... Mutual fund investors are sensitive to fees, and higher advisory fees significantly reduce fund market shares and so constrain fees. (Coates, IV & Hubbard, 2007) Higher expense ratios will never make active funds outperform their passive fund counterparts. (Elton et al., 2019) Further, the launch of new index funds will bring turbulence in the active management funds space and competition. ...
With an increase in the number of fund houses entering the asset management business, the Indian Mutual Fund Industry has turned into a competitive marketplace. An increase in the number of schemes translates to increased choice (and confusion) for investors, while for fund managers, it means more pressure to beat the benchmark indices. Correlation research method is used on scheme variables such as Assets Under Management (AUM), Expense Ratio, and the Monthly Returns of select Indian Midcap Schemes for the period January 2016 to 2021 to determine the statistical relationships between the variables. Three schemes from amongst the midcap schemes, after putting them into clusters, are picked for this study. Findings from this research can help fund managers, and Asset Management Companies (AMCs) better manage their schemes by tweaking expenses and further maximizing investor returns.
... Prominent critics (Bogle, 2003;Swensen, 2005;Spitzer, 2004;Freeman and Brown, 2001) argued that mutual funds did not compete in a competitive market. Others (e.g., Coates and Hubbard, 2007;Wahal and Wang, 2011;Khorana and Servaes, 2012) responded, however, with economic arguments and empirical evidence suggesting that the mutual fund market was indeed a competitive market. Wahal and Wang's (2011) study was particularly suasive. ...
I advance an explanation for durable dominance???dominants??? enduring control of vastly disproportionate shares of contested resources in the face of mass entrepreneurial entry and increased competitive parity. I argue that increased, more potent competitive entry and more level rules of competition can benefit dominants. More and stronger new entrants disproportionately disadvantage non-dominants compared to dominants, and weaken near-dominants??? ability to challenge dominants. Durable dominance is observed in many settings, for example, in the increased gap between the wealthiest in the U.S. and everyone else, and in industries where dominant companies maintain their dominance in open, competitive markets.
I test the predictions of this theory in two settings. First, I investigate the implications of this theory with thirty years of data on competition among U.S. mutual funds. As predicted by the theory, the effects of increased competitive entry on incumbents were nonlinear: deleterious for incumbent funds on average, but beneficial for dominant funds. New entry of similar competitors depressed future annual flows of investor money into 96.5% of mutual funds, but the top 1.3% of mutual funds gained on average almost $70 million of assets under management from the entry of a similar competitor. Increased competitive entry also increased dominant funds??? probability of remaining dominant for longer than three years.
Second, I examine the process of board seat accumulation for directors on the boards of S&P1500 companies. Those with many board seats (dominant directors) compared to those with only one were about twice as likely to gain another seat in 2000, but no more likely by 2010. The theory predicts that such a leveled playing field should prevent non-dominants from rising to dominance, and the data support this prediction. A Monte Carlo simulation supports the causal relationship between the changed micro-dynamics of hiring and the observed non-appearance of new dominant directors.
The proposed theory suggests policy implications for dominants, non-dominants, and policy-makers. I close by suggesting future investigations that could test the general applicability of the theory. I argue that the study of most-often-true ???social laws??? is a useful complement to the current focus on social mechanisms in organization theory.
... In contrast, Stiroh and Rumble (2006) and Golez and Marin (2012) argue that there is no evidence for such gains in banking. 7 Among the more prominent academic studies to argue that there is insufficient competition to constrain mutual fund fees are Freeman and Brown (2003) and Freeman et al. (2008), while the case for the presence of effective competition can be found in Coates and Hubbard (2007). This controversy has spawned considerable litigation in the form of class action suits against mutual fund advisors, the history of which is detailed in these academic studies. ...
We analyze gains from intercorporate sales of mutual fund subsidiaries, using mandated SEC disclosures to assess the performance of mutual funds transferred by these transactions. Sellers are financial conglomerates (banks) using equity-based deals to transfer poorly performing funds to highly focused asset management companies. The transferred funds experience significant improvements in net returns, efficiency, and asset growth. These improvements are closely correlated with the gains in wealth to buyers and sellers at deal announcements, indicating the market efficiently capitalizes expected performance improvements. Our results provide evidence that these transactions transfer assets to acquirers better able to manage them, generating gains for fundholders and buyer and seller shareholders.
... A large number of studies focus on competition between fund managers with AUM-based fees. Only two seem to emphasize the bright side: Coates and Hubbard (2007) argue that fierce competition exerts a strong disciplinary force on fund managers, thereby reducing the need for extensive legal intervention to protect fund investors. Morley and Curtis (2010) claim that competition can substitute for both governance regulation and litigation. ...
Regulators worldwide take the view that incentives aligning the interests of retirement savings fund managers with those of their clients should be provided by competition and not by performance-based fees. We use a regulatory experiment from Israel to examine the effects of incentive fees and competition on the performance of retirement savings schemes. Taking advantage of a unique institutional setup, we compare three exogenously-given types of savings schemes operated by the same management companies contemporaneously: (i) funds with performance-based fees, facing no competition; (ii) funds with AUM-based fees, facing minimal competitive pressure; and (iii) funds with AUM-based fees, operating in a highly competitive environment. We find that funds with performance-based fees exhibit high returns, high risk and high α. By contrast, we find no significant differences in performance due to competitive pressures. We conclude that incentives and competition are not perfect substitutes in the retirement savings industry. We also conjecture that the ubiquitous regulatory restrictions on the use of explicit incentives in fund management may be inefficient, and should perhaps be reconsidered.
... Aggarwal and Jorion [19] find no evidence that a willingness to offer private transparency harms fund returns and no support for concerns that managers offering transparency suffer from selection bias. Coates IV and Hubbard [20] argue against regulation on mutual fund fees by presenting that competition exerts strong disciplinary force on funds. From a legal perspective Palmiter [21] argues that mutual fund boards perform poorly as "watchdog" supervisors of the management firms. ...
This paper studies the impact of external monitoring on the behavior in mutual funds. Specifically, we investigate how and why external monitoring can alleviate contracting inefficiency caused by information asymmetry between investors and the manager. It is shown that efficiency loss emerges when investors contract with the manager just relying on her investment return history. The establishment of external monitoring that provides investors more information about the manager’s ability can improve contracting efficiency, which converges to first-best as external monitoring strengthens. These results provide strong support for tightening supervision in mutual fund industry.
... Public interest in the mutual fund industry has grown rapidly during the past few decades, and the supply of funds has grown extensively (Coates and Hubbard, 2007). Researchers investigating mutual fund investments have concluded that fund inflows to well-performing funds are much greater than fund outflows from poorly performing funds (Sirri and Tufano, 1998). ...
Purpose
The purpose of this paper is to investigate the impact of financial literacy, risk attitude, and saving motives on the attenuation of mutual fund investors’ disposition bias. Specifically, the authors focus on individual characteristics explaining the investors’ propensity to sell shares in a poorly performing mutual fund.
Design/methodology/approach
The study relies on survey data collected from 1,564 Swedish households in 2013. The authors test the hypotheses considering three different portfolio compositions and portfolio performances. Each composition corresponds to a dependent variable and a separate model which are estimated using ordinal logistic regression.
Findings
The authors find that different forms of financial literacy affect attenuation of the disposition effect. Specifically, the authors find that knowledge about mutual funds and knowledge about current market conditions affect the attenuation of the disposition effect, whereas the authors find no support for the effect of “technical financial knowledge” (e.g. the ability to calculate compound interest rates). The authors also find no support for the effects of risk attitude and saving motives on the attenuation of the disposition bias.
Originality/value
The findings suggest a need for a more fine-grained conceptualization of the financial literacy concept and its effect on investors’ disposition bias. Since an important implication of the findings is that financial literacy could potentially help people overcome behavioral bias, the study provides insights for policymakers as well as into the discussion on the design of consumer education programs.
... Balyeate (2007) finds that when investors are subject to behavioral biases, or the negative effects of competition induced arbitrage, that education and disclosure might be the solution. Coates and Hubbard (2007) discuss some of the prior government intervention, by reporting that Congress, in the ICA Section 36(b) ruling, established an upper bound on the range of fees that an advisor could charge to a fund. According to West (2012), irrational decisions are experienced by both sophisticated and unsophisticated investors because investors experience behavioral biases and either cannot obtain or understand the product and service descriptions. ...
... Because the manager has a greater interest in maximizing the size of the fund than do investors, the manager may spend more of the shareholders' money on marketing than the shareholders would prefer. (p. 5) Freeman [2006] critiques "the mutual fund distribution expense mess" and its agency conf licts. When Rule 12b-1 was adopted, it was argued mutual fund shareholders would benefit from scale economies generated by growth in fund assets. ...
This article provides in-depth discussion of important issues related to mutual fund distribution. The first
two topics are fund distribution channel characteristics and Rule 12b-1 fees and distribution. Distribution
channel characteristics discuss direct channel, advice channel, retirement channel, institutional channel,
supermarket channel, and multiple-share classes. The discussion of Rule 12b-1 fees and distribution covers
adoption of Rule 12b-1, Rule 12b-1 after adoption, current 12b-1 fees, issues with 12b-1 fees, and summary
of 12b-1 fees attributes. The remaining topics include direct-sold and broker-sold services, Rule 12b-1 fees
and revenue sharing, revenue sharing issues, soft-dollar trading, distribution and f lows, opacity and agency conf
licts, expense shifting agency conf licts, and intermediated distribution and portfolio managers.
... Thus, an interest in improving relative performance could well lead active fund managers to place more weight on gains to their portfolios from access to corporate managers relative to gains from governance-generated increases in value, compared to what would be optimal for the investment funds' beneficial investors. 3 Finally, without discussing the issue in detail, we want to flag a disagreement in the literature regarding the extent to which fund inflows and outflows are sensitive to changes in relative performance (for example, Sirri and Tufano 1998 and Coates and Hubbard 2007). To the extent that the sensitivity of inflows and outflows to performance is limited, competition with other investment funds will give investment managers limited incentives to improve the value of portfolio companies. ...
Financial economics and corporate governance have long focused on the agency problems between corporate managers and shareholders that result from the dispersion of ownership in large publicly traded corporations. In this paper, we focus on how the rise of institutional investors over the past several decades has transformed the corporate landscape and, in turn, the governance problems of the modern corporation. The rise of institutional investors has led to increased concentration of equity ownership, with most public corporations now having a substantial proportion of their shares held by a small number of institutional investors. At the same time, these institutions are controlled by investment managers, which have their own agency problems vis-à-vis their own beneficial investors. We develop an analytical framework for understanding the agency problems of institutional investors, and apply it to examine the agency problems and behavior of several key types of investment managers, including those that manage mutual funds—both index funds and actively managed funds—and activist hedge funds. We show that index funds have especially poor incentives to engage in stewardship activities that could improve governance and increase value. Activist hedge funds have substantially better incentives than managers of index funds or active mutual funds. While their activities may partially compensate, we show that they do not provide a complete solution for the agency problems of other institutional investors.
... A large number of studies focus on competition between fund managers with AUM-based fees. Only two seem to emphasize the bright side: Coates and Hubbard (2007) argue that fierce competition exerts a strong disciplinary force on fund managers, thereby reducing the need for extensive legal intervention to protect fund investors. ...
Regulators worldwide take the view that incentives aligning the interests of retirement savings fund managers with those of their clients should be provided by competition and not by performance-based fees. We use a regulatory experiment from Israel to examine the effects of incentive fees and competition on the performance of retirement savings schemes. Taking advantage of a unique institutional setup, we compare three exogenously-given types of savings schemes operated by the same management companies contemporaneously: (i) funds with performance-based fees, facing no competition; (ii) funds with AUM-based fees, facing minimal competitive pressure; and (iii) funds with AUM-based fees, operating in a highly competitive environment. We find that funds with performance-based fees exhibit high returns, high risk and high α. By contrast, we find no significant differences in performance due to competitive pressures. We conclude that incentives and competition are not perfect substitutes in the retirement savings industry. We also conjecture that the ubiquitous regulatory restrictions on the use of explicit incentives in fund management may be inefficient, and should perhaps be reconsidered.
... Our findings contribute new insights into households' financial decision-making. Such insights are important because public interest in the mutual fund industry has rapidly grown in several countries during the past few decades, and the supply of funds has extensively grown (Coates and Hubbard, 2007). Thus, households' financial decisions regarding mutual fund investments are important for both households and the greater economy. ...
We investigate characteristics of household investors stating they would increase shares in a mutual fund in a situation where this fund has exhibited a negative past performance. Hence, we investigate characteristics of investors behaving lite contrarians. We use a survey methodology to examine the effects of risk tolerance, perceived competence, and of being informed on households’ contrarian behavior. To investigate the stability of these characteristics we test our hypothesis in three scenarios: (1) scenario without consideration of market conditions, (2) bull market scenario, and (3) bear market scenario. Findings show that risk tolerance and perceived competence leads to a contrarian buying behavior. The results show that these effects are significant also in bull and bear markets, thus that these characteristics are stable. The findings further show that being informed explains contrarian buying behavior only when no consideration is given to current market conditions. Thus, this characteristic could be considered unstable.
... Families receiving grades of "A" in both criteria for all their funds include Clipper, FPA, Longleaf Partners, and Selected Funds. Freeman (2007) argues that mutual fund industry governance in general has failed. If boards of directors acted in their designated capacity as fiduciaries, mutual fund fees would reflect competitive pricing. ...
This chapter discusses the size and market concentration of the mutual fund industry, the market entry and exit of mutual funds, the benefits and costs of mutual fund size changes, principal benefits and costs of ownership from fund shareholders’ perspective, and mutual fund governance.
... We now turn to the literature on competition between fund managers with AUM-based fees. Coates and Hubbard (2007) argue that fierce competition exerts a strong disciplinary force on mutual funds, thereby reducing the need for legal intervention to prevent funds from charging excessive fees. Morley and Curtis (2010) claim that competition can substitute for both governance regulation and litigation. ...
... • Significant economies of scale Examples include the presence of fixed expenses associated with portfolio management, such as brokerage commissions being typically charged as a flat fee per transaction irrespective of the number of shares bought or sold (the same being true of custodial fees paid to banks); the cost of regulatory compliance (e.g. preparing filings to the Securities and Exchange Commission); and the cost of due diligence for investments (Coates and Hubbard 2007;Dyck and Pomorski 2011;Latzco 1999;Malkiel 2013). See more generally Piketty (2013, p. 719). ...
In this paper we study the extent to which the financial market has contributed to wealth disparities. To that end we introduce a stochastic dynamic model of wealth accumulation with preferences, consumption and portfolio choice, which roughly replicates the long-term evolution of assets under management. Using a receding horizon approach for solving nonlinear model predictive control (NMPC) in finite time, we run simulations with three types of investors (conservative, moderate and aggressive) corresponding, roughly, to the social population segments identified in Piketty (Le capital au XXIe siècle, Seuil, Paris, 2013) for thinking about distributional matters, namely the lower segment (bottom 50%), the middle segment (middle 40%), and the upper segment (upper 10%) respectively. We estimate the impact on the end wealth distribution of first, investor-level characteristics (calibrated for each investor class), which directly impact the saving rate; and second, higher expected returns for wealthier (aggressive) investors in the top decile through the availability of leverage. We find that differences in investor-level characteristics (and significantly the length of the receding horizon) combined with access to leverage are sufficient to generate fat tails. Though results are obtained in a stochastic approach, the outcomes are less related to stochastic shocks than to some feedback and scale effects operating in favor of some investors in the financial market.
... 13 This is the same attitude that the Court took in Wsol (2001) , holding that, as a result, there may be a breach of fi duciary duty without remedy. 14 To be sure, under the Advisers Act of 1940 and the ' Brochure Rule ' that registered advisers must provide potential clients a brochure, the advisers must also state whether their charges are higher than the market charges (set at 3 per cent) ( 17 C.F.R. § 275.204-3, 2009 Coates and Hubbard (2007) . 21 ' A fi duciary must make full disclosure and play no tricks but is not subject to a cap on compensation ' . ...
The case of Jones v. Harris (2008a) that is currently before the Supreme Court poses issues with regard to mutual fund managers' fees and expense (Advisory Fees). However, the case may signal the direction courts will take in reviewing management compensation of large corporations as well. Advisory Fees pose a number of fundamental issues that appear in many fiduciary relationships. First, why do the fees and compensation of fiduciaries raise unique problems? Second, what are the solutions to the fee problem? Third, what is the role of the courts in the determination of Advisory Fees? Fourth, what are the tests that the courts or the boards of the mutual funds should apply in determining Advisory Fees? Fifth, how did the Seventh Circuit decision in Jones v. Harris determine these questions? Sixth, what are the implications of Jones v. Harris? In conclusion, by analyzing these questions we might uncover guidelines to the issues with regard to corporate executive compensation as well.
... In addition, these studies could throw some light on competition in this sector. Coates and Hubbard (2007) draw up an excellent analysis of that issue. Gil-Bazo and Ruiz-Verdú (2008) present another recent theoretical contribution to the relevant literature. ...
The aim of this paper is to analyse the dynamic price-setting (through changes in the management fees) in the Spanish mutual fund industry. The study is applied to a sample of Spanish mutual funds from 2002 to 2007. Management fee changes account only for a 4% of the observations, but they are economically significant. A substantial 29% of the total number of funds is involved on management fee changes along the sample period, with an average change larger than 50 basis points. Results seem to reveal that small and poor-performer funds (and also management companies) have decreased asset-based management fees as a way to improve its degree of competition in the industry. However, no significant subsequent effects of such changes are found in the paper. Small funds, with low excess returns, high quarterly returns and being owned by good performer management companies have decreased performance-based management fees. These performance-based management fee decreases seem to have had a negative effect on the subsequent returns and on the net excess returns and a positive impact on the fund market share. It seems that the decrease of the performance fees causes that the manager put a minor effort, because of performance-based fee is an explicit incentive for the manager.
... On the other hand, both commercial firms and pension plan providers are likely to be seen as having higher levels of expertise than not-for-profit firms and independent intermediaries, since without such high expertise these firms would not be able to survive in a highly sophisticated, regulated, and competitive market such as that for pension plans (see e.g. Coates and Hubbard 2007). Advice acceptance may also vary, depending on aspects of the interaction on which the advice is based (Briggs, De Angeli, and Lynch 2002, Dabholkar and Bagozzi 2002, Dellaert and Dabholkar 2009, Kramer 2007. ...
Relatively little is known about what drives individuals’ acceptance of online pension investment advice and, from a consumer point of view, which firms may be best placed to provide such advice. The aim of the current paper is to generate novel insights that shed light on these questions by conducting (1) a review of the current literature and (2) a preliminary ‘real-world’ exploratory study using an innovative online pension investment advice tool (the ‘Pension Builder’) and a representative sample of the Dutch population.
... Our second contribution is to analyze the coexistence of capped fees with those that are charged at the fund managers' discretion. Discretionary fees such as sales service, information 1 See Coates and Hubbard (2007) for a comprehensive summary of the fee debate in the U.S. 2 See "RBC & China Minsheng in Joint Venture", The Toronto Star, 31 October 2006. Management fees are fees that are paid out of fund assets to the fund's investment adviser for doing research and investment portfolio management while custody fees are fees paid to a third party to hold and transfer the securities of the fund. ...
This paper investigates mutual fund fee setting behavior around regulated fee caps or ceilings in Chinese stock funds from 2004 to 2007, following the introduction of the Chinese Securities Investment Law. Contemporary empirical research on the efficacy of mutual fund fee regulation is limited even though caps are touted as means of investor protection. The results suggest that funds are more likely to charge management fees near the regulated ceiling over time. Fee ceilings have a perverse impact as their presence is significantly correlated with higher unregulated fees. These findings demonstrate that fee ceilings do not only weaken competition, but also increase discretionary fees charged to investors.
... Whether fund fees are excessive and whether market competition truly works in the mutual fund industry is a long-standing debate among academics. Several studies such as Coates and Hubbard (2007) and Grinblatt, Ikheimo, and Keloharju (2008) argue that there is an adequate level of competition in the mutual fund industry and fees in the fund market are thus competitive. However, the result of our empirical study contradicts this view. ...
Why are investors buying underperforming mutual funds? To address this problem, 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. For these fees to be justified, we show that 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. We demonstrate that investors' over-optimism and their misperception about the fund market drive them into buying underperforming mutual funds, which then allows mutual fund managers to charge high markups.
... However, so far these studies have mainly examined the effect of competition on fund fees (Wahal and Wang 2010;Khorana and Servaes, 2004;Coates and Hubbard 2007;Gil-Bazo and Luis-Verdu 2009). The impact of competition on fund performance has not been examined. ...
We examine how competition affects the performance of active equity mutual funds aggressively pursuing the post earnings announcement drift (PEAD). We find that competition significantly erodes the performance of these funds. Amid increased competition, there is also increased diversity in the sophistication of implementing the strategy by funds. A group of funds aggressively pursuing the strategy successfully avoid competition and generate superior performance. The identities of these low-competition funds are persistent. Moreover, these funds tend to hold and trade on stocks with high trading costs and high idiosyncratic volatility, presumably to avoid crowding. Our findings suggest that for these low-competition funds, the benefit of avoiding competition outweighs the downside of incurring high trading costs.
From 1980 to 2006, the financial services sector of the US economy grew from 4.9 percent to 8.3 percent of GDP. A substantial share of that increase was comprised of increases in the fees paid for asset management. This paper examines the significant increase in asset management fees charged to both individual and institutional investors. One could argue that the increase in fees charged by actively managed funds could prove to be socially useful if it reflected increasing returns for investors from active management or if it was necessary to improve the efficiency of the market for investors who availed themselves of low-cost passive (index) funds. But neither of these arguments can be supported by the data. Actively managed funds of publicly traded securities have consistently underperformed index funds, and the amount of the underperformance is well approximated by the difference in the fees charged by the two types of funds. Moreover, it appears that there was no change in the efficiency of the market from 1980 to 2011. Thus, the increase in fees is likely to represent a deadweight loss for investors. Indeed, perhaps the greatest inefficiency in the stock market is in “the market” for investment advice.
U.S. regulation of public investment companies (such as mutual funds) is based on a notion that, from a governance perspective, investment companies are simply another type of business enterprise, not substantially different from companies that produce goods or provide (non-investment) services. In other words, investment company regulation is founded on what this Article calls a “corporate governance paradigm,” in that it provides a significant regulatory role for boards of directors, as the traditional governance mechanism in business enterprises, and is “entity-centric,” focusing on intra-entity relationships to the exclusion of super-entity ones. This Article argues that corporate governance norms, which came to dominate U.S. investment company regulation as a result of the unique history of U.S. investment companies, are poorly-suited to achieve the goals of investment company regulation. In particular, the corporate governance paradigm has given rise to a number of regulatory weaknesses, which stem from investment advisers’ effective control over investment company boards of directors and courts’ deference to state corporate law doctrine in addressing investors’ grievances. Accordingly, investment company regulation should acknowledge that investment companies are not merely another type of business enterprise with the same challenges and tensions arising from the separation of ownership and control that appear in the traditional corporate context. Toward that end, this Article contends that policymakers should view, and regulate, investment companies as an avenue through which investment advisers provide financial services (investment advisory services, in particular) to investors — and should view investment company shareholders more as advisory customers than as equity owners of a firm. This “financial services” model of regulation moves past the entity-focus of corporate governance norms and, therefore, permits dispensing with governance by an “independent” body such as the board of directors. More importantly, if adopted, this model would remedy some of the more significant problems plaguing U.S. investment company regulation.
Despite their obvious affinity on many matters related to law and economics, Judges Frank Easterbrook and Richard Posner recently engaged in a fierce battle over the economics of the mutual fund industry and over statutory interpretation in Jones v. Harris Associates, L.P., a case challenging the fees paid to a fund’s investment adviser. Chief Judge Easterbrook, writing for the panel, held that under § 36(b) of the Investment Company Act, advisers have a duty of full disclosure and must avoid fraud, but are not subject to a limit on compensation. In dissent, Judge Posner argued that the Jones decision is based “on an economic analysis that is ripe for reexamination.” It is true that the panel opinion relies heavily upon an economic analysis that counts on competition to restrain adviser compensation and whose validity the recent collapse of the financial services industry calls into question. But the opinion can best be viewed as a product of Judge Easterbrook's public choice theory of statutory interpretation: strict textualism based upon an extreme skepticism of legislation and of judicial discretion. That theory leads the court in Jones to reach a conclusion that ignores the text, structure, and history of § 36(b), and that nullifies the intended effect of the statute. Moreover, the decision suggests that Easterbrook’s theory of interpretation is inadequate as a solitary tool for interpreting statutes. Public choice principles help us to set limits upon interpretation, but they do not provide a guide to interpretation within those limits. Without a balancing principle of fidelity to congressional purpose, Easterbrook’s theory comes dangerously close to a different form of judicial activism: using strict construction as a means for eviscerating legislation of any practical effect.
This article contrasts how a robust conception of director independence plays a central role in the corporate law world while, in the mutual fund industry, independence is a shrunken conception playing only a marginal role. Over the last twenty-five years, director independence in corporate law has gained wide acceptance as being desirable and it has become a critical component of fiduciary duty analysis. Within the mutual fund industry, however, independence remains fiercely contested. The more obvious battle over independence has occurred in response to the Securities and Exchange Commission's ("SEC's") rulemaking effort to alter the standard for granting certain regulatory privileges under the Investment Company Act (the "Act"). The SEC, among other reforms, sought to limit those privileges to companies where at least seventy-five percent of the directors, and the board chairman, are "independent." Twice, those rulemaking efforts have been struck down on procedural grounds. In late 2006, the SEC resolicited public comment on two studies addressing the costs and benefits of the proposals but has not yet reissued a rule. Independence is also important, however, under section 36(b) of the Act, which permits an investor to sue an investment advisor for breaching its fiduciary duty with respect to compensation for managing the mutual fund. In 1982, the seminal Gartenberg case articulated six factors to guide the determination of an excessive fee. One of the factors is independence but, unlike the case in corporate law, over the last quarter of a century it has remained a narrow concept of little significance, being referred to in only 29 of 139 decisions citing Gartenberg and playing no meaningful role in the resolution of any cases. In no case has an investor ever obtained a judgment under section 36(b). This article, after a critical analysis of Gartenberg on its silver anniversary, offers a proposal for reinvigorating independence in the mutual fund litigation context. It cites evidence that a more capacious definition of independence - one going beyond the related but narrower notion of "disinterestedness" - may correlate with the size of advisor fees. It advocates importing into the mutual fund world the fuller-bodied notion of independence that has evolved in Delaware over the last quarter century. There is no statutory or policy reason for the "independence" factor under Gartenberg - seemingly frozen in the early 1980s - not to similarly expand and so play a more significant role in fee litigation under the Act. Doing so will help restore private litigation as a vital component of Congress' regulatory strategy for protecting investors in mutual funds.
In Creating a World Without Poverty, Muhammad Yunus introduces the social business model which aims to provide a social benefit, not just a monetary profit. This model is distinct from a typical non-profit charity because investors expect to eventually recover their financial contributions to the social business. Yunus describes the Danone Communities mutual fund’s ability to protect the company from liability to shareholders for lack of a monetary profit while simultaneously providing food to malnourished children in Bangladesh. This Comment examines two different successful social business structures and argues that companies have yet to embrace this innovative model due to a lack of clear guidelines for this type of business in United States corporate law. The enactment of mutual fund regulations encouraging the creation of this forprofit sustainable social business would allow it to be very successful in reducing poverty.
This short review presents a selected history of the mutual fertilization
between physics and economics, from Isaac Newton and Adam Smith to the present.
The fundamentally different perspectives embraced in theories developed in
financial economics compared with physics are dissected with the examples of
the volatility smile and of the excess volatility puzzle. The role of the Ising
model of phase transitions to model social and financial systems is reviewed,
with the concepts of random utilities and the logit model as the analog of the
Boltzmann factor in statistic physics. Recent extensions in term of quantum
decision theory are also covered. A wealth of models are discussed briefly that
build on the Ising model and generalize it to account for the many stylized
facts of financial markets. A summary of the relevance of the Ising model and
its extensions is provided to account for financial bubbles and crashes. The
review would be incomplete if it would not cover the dynamical field of agent
based models (ABMs), also known as computational economic models, of which the
Ising-type models are just special ABM implementations. We formulate the
``Emerging Market Intelligence hypothesis'' to reconcile the pervasive presence
of ``noise traders'' with the near efficiency of financial markets. Finally, we
note that evolutionary biology, more than physics, is now playing a growing
role to inspire models of financial markets.
We examine the relation between indexing and active management in the mutual fund industry worldwide. Explicit indexing and closet indexing by active funds are associated with countries’ regulatory and financial market environments. We find that actively managed funds are more active and charge lower fees when they face more competitive pressure from low-cost explicitly indexed funds. A quasi-natural experiment using the exogenous variation in indexed funds generated by the passage of pension laws supports a causal interpretation of the results. Moreover, the average alpha generated by active management is higher in countries with more explicit indexing and lower in countries with more closet indexing. Overall, our evidence suggests that explicit indexing improves competition in the mutual fund industry.
There is mounting evidence that retail investors make predictable, costly investment mistakes, including underinvestment, naïve diversification, and payment of excessive fund fees. Over the past thirty-five years, however, participant-directed 401(k) plans have largely replaced professionally managed pension plans, requiring unsophisticated retail investors to navigate the financial markets themselves. Policy-makers have struggled with regulatory interventions designed to improve the quality of investment decisions without a clear understanding of the reasons for investor mistakes. Absent such an understanding, it is difficult to design effective regulatory responses.This article offers a first step in understanding the investor decision-making process. We use an internet-based experiment to disentangle possible explanations for inefficient investment decisions. The experiment employs a simplified construct of an employee’s allocation among the options in a retirement plan coupled with technology that enables us to collect data on the specific information that investors choose to view. In addition to collecting general information about the process by which investors choose among mutual fund options, we employ an experimental manipulation to test the effect of an instruction on the importance of mutual fund fees. Pairing this instruction with simplified fee disclosure allows us to distinguish between motivation-limits and cognition-limits as explanations for the widespread findings that investors ignore fees in their investment decisions.Our results offer partial but limited grounds for optimism. On the one hand, within our simplified experimental construct, our subjects allocated more money, on average, to higher-value funds. Furthermore, subjects who received the fees instruction paid closer attention to mutual fund fees and allocated their investments into funds with lower fees. On the other hand, the effects of even a blunt fees instruction were limited, and investors were unable to identify and avoid clearly inferior fund options. In addition, our results suggest that excessive, naïve diversification strategies are driving many investment decisions. Although our findings are preliminary, they suggest valuable avenues for future research and important implications for regulation of retail investing.
This article explores the effects of competition on risk-taking behavior and firm performance within the financial services industry. It does so by exploiting a regulatory change that allowed new players to enter the British mutual fund industry. Exploiting this regulatory shock, we trace nontrivial linkages among industry competition, risk taking, and performance. Greater competition followed the regulatory liberalization, leading to a significant increase in risk-taking behavior of funds. Competition generated performance efficiencies, forcing underperforming funds to exit and halting earlier value destruction. Competition, however, did not produce tangible cost savings for consumers of investment services.
This chapter provides an in-depth discussion of important issues related to mutual fund distribution. Two major topics are fund distribution channel characteristics and Rule 12b-1 fees and distribution. Distribution channel characteristics discussed include direct channel, advice channel, retirement channel, institutional channel, supermarket channel, and multiple-share classes. Rule 12b-1 fees and distribution discuss adoption
of Rule 12b-1, Rule 12b-1 after adoption, current 12b-1 fees, and issues with 12b-1 fees.
A final major topic discussed direct-sold and broker-sold services. The 12b-1 fee compensates brokers for initial sales of fund shares, ongoing servicing of fund shareholder accounts, and advertising and promotion expenses. Higher broker sales increase fund adviser assets under management (higher inflows) and adviser
profits-primary motivations. Additionally, higher fund share sales increase broker profits, while higher broker fund share sales increase the size and cost of fund portfolio trades, amounts of broker commissions, and execution fees. Higher 12b-1 fees increase fund outflows, but higher share sales increase fund inflows. Rule12b-1 fees are transparent direct line-item costs in fund expense ratios that motivate using multiple share
classes in direct and broker (and other intermediary) sold funds, including sales of fund shares to large individual and institutional investors. Payments reduce current fund net asset values (NAVs) and shareholder returns. Lastly, 12b-1 fees provide major agency conflicts with shareholder interests and returns.
This Article offers a broad theory of what distinguishes investment funds from ordinary companies, with ramifications for how these funds are understood and regulated. The central claim is that investment funds (i.e., mutual funds, hedge funds, private equity funds, and their cousins) are distinguished not by the assets they hold, but by their unique organizational structures, which separate investment assets and management assets into different entities with different owners. In this structure, the investments belong to "funds, " while the management assets belong to "management companies." This structure benefits investors in the funds in a rather paradoxical way: it restricts their rights to control their managers and to share in their managers' profits and liabilities. The fund investors accept these restrictions because certain features common to most investment funds make these restrictions efficient. Those features include powerful investor exit rights that substitute for control rights and economies of scope and scale that encourage managers to operate multiple funds at the same time. This understanding illuminates a number of key areas of contracting and regulation and refutes the claims of skeptics who say that fund investors would be better off if they employed their managers directly.
Disclosures are among the most common techniques introduced. The purpose of such regulation is to correct, for the benefit of the potential retail investor, information asymmetries relating to the characteristics of the financial products and the motivations of the intermediary advisor. The devil is in the detail, however, and it has become apparent that disclosing without assessing “how” to disclose may create unexpected and harmful side-effects. For this reason, there is a need for a research agenda centred around the limits deriving from motivation in the use of financial information and in good decision- making. This research design would disentangle connections between financial law and emotions and, in particular, financial law and happiness as well as financial law and altruism.
Prior research shows that increasing the breadth of elements used to create a firm's innovations can improve its ability to successfully introduce innovations. Yet, our understanding of the antecedents of innovation breadth is limited. This study investigates how competition affects product managers' decision to expand the breadth of elements used to create an innovation. I build on the awareness–motivation–capability (AMC) framework to propose that inter-firm competition from rivals' innovations and intra-firm competition from a firm's own innovations both create pressures for product managers to increase innovation breadth, but that the greater awareness and motivation resulting from internal competition will lead managers to increase innovation breadth more in response to intra-firm competition. I find support for these propositions based on a longitudinal examination of mutual fund innovations. This study offers contributions by developing theory about how competition shapes managers' decision to expand the diversity of elements used to develop an innovation.
A number of studies have been conducted to examine investment performance of mutual funds of the developed capital markets. Grinblatt and Titman (1989, 1994) found that small mutual funds perform better than large ones and that performance is negatively correlated to management fees, but not to fund size or expenses. Hendricks, Patel, and Zeckhauser (1993), Goetzmann and Ibbotson (1994), and Brown and Goetzmann (1995) present evidence of persistence in mutual fund performance. Grinblatt and Titman (1992), and Elton et al. (Journal of Financial Economics 42:397–421, 1996) show that past performance is a good predictor of future performance. Blake, Elton, and Grubber (1993), Detzler (1999), and Philpot, Hearth, Rimbey, and Schulman (1998) find that performance is negatively correlated to fund expense, and that past performance does not predict future performance. However, Philpot, Hearth, and Rimbey (2000) provide evidence of short-term performance persistence in high-yield bond mutual funds. In their studies of money market mutual funds, Domian and Reichenstein (1998) find that the expense ratio is the most important factor in explaining net return differences. Christoffersen (2001) shows that fee waivers matter to performance. Smith and Tito (1969) conducted a study into 38 funds for 1958–67 and obtained similar results. Treyner (Harvard Business Review 43:63–75, 1965) advocated the use of Beta Coefficient instead of the total risk. Statistical Technique used: This paper is intended examine the modeling dimensions of measuring performance of mutual funds during the last 50 years, which leads to innovative research in financial modeling of mutual fund’s performance measure with the help of various models like: regression model, Treynor Model, Lee Model etc..
In June 2004, the SEC required mutual fund boards to disclose additional information about the inputs and processes involved in advisory contract approvals to help investors make more informed decisions and to encourage independent directors to act more independently when negotiating advisory fees. We find that CEF advisory fees are more likely to decrease after the 2004 SEC amendments, especially for those CEFs with high advisory fees and low investment performances. After the 2004 SEC amendments, CEF advisory rates decrease on average and the magnitudes of their decreases increase. We find that more board meetings and the likelihood of a decrease in advisory fees after the amendments increases with the number of board meetings. Our results are not only supported by textual analysis and type of filing downloads but are also robust to time-series placebo tests, changes in the ratios of independent directors, and funds belonging to “scandal” families. Overall, our results are consistent with the notion that the 2004 SEC amendments successfully encouraged independent fund directors to exert more effort and to act more independently in negotiating advisory fees with fund advisors.
We investigate how competition between fund managers and disclosure of other managers’ fees and performance influence fees, risk taken, earnings, and investor concentration, with a controlled lab experiment. We find that more competition and disclosure lead to a reduction in fees: The relative decrease is larger for management fees than for performance fees. Although, the decrease in fees does not affect managers’ investment strategies, it increases investors’ readiness to entrust their funds to a manager. This leads to higher overall earnings, with the benefits going to investors and to fund managers able to attract more or new investors. The empirical literature provides a mixed picture of the consequences of competition in delegated portfolio management, but our results suggest that more competition is mostly beneficial for the development of capital markets.
The literature is still divided about the information asymmetry problems of actively managed mutual funds. This disagreement raises an issue about the conditions behind the existence of this market. Some authors support the existence of market clearing mechanisms, while others estimate that passive funds are a substitute for active funds and the higher fees charged for the latter are not justified. We contribute to this discussion by formalizing these two approaches in price-setting strategies in two subgames. To solve it, we resort to an “external body” with a defined role to coordinate investors and mutual funds. We find that, owing to the actions of the external body and the presence of sophisticated investors and a low-quality mutual fund, there are incentives to deliver high-quality service and the active mutual fund market is preserved.
This paper investigates how the tremendous growth in indexed investments has affected active management in the equity mutual fund industry across 32 countries. Our findings indicate that the growing competition from passive funds does not reduce the fees of actively managed funds. Moreover, active funds do not increase their product differentiation by diverging more from their benchmarks when they face more competitive pressure from indexed products, though they do sometimes charge higher fees and reduce their activity. Thus, our tests indicate that indexed and active funds can coexist and attract different clienteles.
This article contrasts how a robust conception of director independence plays a central role in the corporate law world while, in the mutual fund industry, independence is a shrunken conception playing only a marginal role. Over the last twenty-five years, director independence in corporate law has gained wide acceptance as being desirable and it has become a critical component of fiduciary duty analysis. Within the mutual fund industry, however, independence remains fiercely contested. The more obvious battle over independence has occurred in response to the Securities and Exchange Commission's ("SEC's") rulemaking effort to alter the standard for granting certain regulatory privileges under the Investment Company Act (the "Act"). The SEC, among other reforms, sought to limit those privileges to companies where at least seventy-five percent of the directors, and the board chairman, are "independent." Twice, those rulemaking efforts have been struck down on procedural grounds. In late 2006, the SEC resolicited public comment on two studies addressing the costs and benefits of the proposals but has not yet reissued a rule. Independence is also important, however, under section 36(b) of the Act, which permits an investor to sue an investment advisor for breaching its fiduciary duty with respect to compensation for managing the mutual fund. In 1982, the seminal Gartenberg case articulated six factors to guide the determination of an excessive fee. One of the factors is independence but, unlike the case in corporate law, over the last quarter of a century it has remained a narrow concept of little significance, being referred to in only 29 of 139 decisions citing Gartenberg and playing no meaningful role in the resolution of any cases. In no case has an investor ever obtained a judgment under section 36(b). This article, after a critical analysis of Gartenberg on its silver anniversary, offers a proposal for reinvigorating independence in the mutual fund litigation context. It cites evidence that a more capacious definition of independence - one going beyond the related but narrower notion of "disinterestedness" - may correlate with the size of advisor fees. It advocates importing into the mutual fund world the fuller-bodied notion of independence that has evolved in Delaware over the last quarter century. There is no statutory or policy reason for the "independence" factor under Gartenberg - seemingly frozen in the early 1980s - not to similarly expand and so play a more significant role in fee litigation under the Act. Doing so will help restore private litigation as a vital component of Congress' regulatory strategy for protecting investors in mutual funds.
In the early 1970's, America's mutual fund industry was suffering net redemptions, meaning it was contracting in size. Fund marketing efforts were in disarray, thus prompting the Securities and Exchange Commission (SEC) to embark on a special study analyzing the problems then plaguing the industry. From that starting point, the SEC moved to loosen restrictions on fund marketing in order to foster a more competitive environment. One consequence of this loosening was the explosive growth in mutual funds. Today's industry boasts more than 10,000 funds, with assets exceeding $7 trillion, an average annual asset growth rate since 1974 exceeding twenty percent. A consequence of this staggering growth is that fund sponsors, the SEC, fund investors, and the courts must now confront a new wave of challenges. Despite its phenomenal marketing success, the fund industry now finds aspects of its conduct under attack from various quarters. The popular press and a prominent regulator, Eliot Spitzer, are focusing attention on the industry's fee structure and the perceived inadequacy of mutual fund governance, including the gap between prices charged funds for advisory services versus prices fetched elsewhere in the economy for those same services. This article examines whether the chief product that shareholders buy when they invest in mutual funds - professional investment advice - is being systematically over-priced by fund managers. The emphasis is on advisory fees imposed on equity mutual funds. Part II explains how the industry's unique management structure accounts for the alleged lack of price competition in the delivery of management advice perceived by the industry's detractors. Part III examines two questions related to economies of scale in the fund industry. First, do economies of scale exist for the delivery of investment management services to equity fund shareholders? Second, if so, are those economies being shared fairly with the funds' owners by the funds' agents, the investment advisors? Part IV studies causes for the status quo, including the industry's statutory scheme, the quality of the SEC's regulatory efforts, and the reception given fund critics by the courts. The Article concludes with a set of proposals for changing the present competitive environment in which fund advisory fees are set, disclosed, and evaluated.
Delaware courts largely have privatized enforcement of fiduciary duties in public corporations and have expressly acknowledged this judicial policy. The Delaware courts also recognize that so encouraging private enforcement creates an obvious danger: Plaintiffs' attorneys, especially in class actions where there is no strongly interested plaintiff, may make litigation-related decisions primarily with a view to advancing their own economic interests, rather than advancing the interests of the corporation or shareholders that they purport to represent. Such decisions have the potential to impose substantial, litigation-related agency costs on corporations, shareholders and the courts, if not appropriately curbed through judicial monitoring of settlements and fee awards. This paper examines the development of Delaware law with respect to merger-related class actions, which have become the dominant form of shareholder litigation in Delaware. We offer two broad alternative hypotheses as to what drives merger-related class actions in Delaware: a "shareholder champion" hypothesis, and a "self-interested litigator" hypothesis. We then examine intensively all large mergers in 1999-2001 where the target was a publicly traded Delaware company, and all class actions filed with respect to those mergers. We conduct statistical analyses as well as a detailed qualitative analysis of the 104 class actions filed during those years. The pattern that we observe is redolent of a pattern of opportunistic filings, of a lawyer-driven process rather than a true client-driven process: systematic behavior with respect to which mergers were challenged; early and frequent complaints filed; a very high percentage of dismissed cases never reached a judgment on the merits; the absence of a single case that has been decided in favor of the plaintiffs on the merits; settlements tending to reflect free riding by plaintiffs' attorneys; plaintiffs' attorneys failing to challenge special negotiating committees' decisions or competing offers; attorneys with "real" clients and from outside the "traditional" Delaware plaintiffs' bar who were far more vigorous in their litigation efforts; no settlements overturned by the Delaware courts; plaintiffs' attorneys' fee awards in settlements usually paid by defendants and not out of common funds, and largely unchallenged; and plaintiffs' attorneys' fees representing a strikingly low percentage of claimed recoveries (but attractive on an hourly basis), which may well indicate that the attorneys added little value to the recoveries. We then offer suggestions as to changes in pleading standards and the Delaware courts' approach to reviewing settlements and plaintiffs' attorneys' fees that would help curb the excesses of class action litigation without seriously undermining the constructive role that plaintiffs' attorneys have the potential to play in policing corporate mis-governance with respect to mergers.
Using the result that under the null hypothesis of no misspecification an asymptotically efficient estimator must have zero asymptotic covariance with its difference from a consistent but asymptotically inefficient estimator, specification tests are devised for a number of model specifications in econometrics. Local power is calculated for small departures from the null hypothesis. An instrumental variable test as well as tests for a time series cross section model and the simultaneous equation model are presented. An empirical model provides evidence that unobserved individual factors are present which are not orthogonal to the included right-hand-side variable in a common econometric specification of an individual wage equation.
This paper examines four million daily price observations for more than 1,000 consumer electronics products on the price comparison site http://Shopper.com . We find little support for the notion that prices on the Internet are converging to the 'law of one price.' In addition, observed levels of price dispersion vary systematically with the number of firms listing prices. The difference between the two lowest prices (the 'gap') averages 23 per cent when two firms list prices, and falls to 3.5 per cent in markets where 17 firms list prices. These empirical results are an implication of a general 'clearinghouse' model of equilibrium price dispersion. Copyright Blackwell Publishing Ltd. 2004.
Internet shopbots compare prices and services levels at competing retailers, creating a laboratory for analysing consumer choice. We analyse 20,268 shopbot consumers who select various books from 33 retailers over 69 days. Although each retailer offers a homogeneous product, we find that brand is an important determinant of consumer choice. The three most heavily branded retailers hold a $1.72 price advantage over more generic retailers in head-to-head price comparisons. In particular, we find that consumers use brand as a proxy for retailer credibility in non-contractible aspects of the product and service bundle, such as shipping reliability. Copyright 2001 by Blackwell Publishing Ltd
Mutual funds represent one of the fastest growing type of financial intermediary in the American economy. The question remains as to why mutual funds and in particular actively managed mutual funds have grown so fast, when their performance on average has been inferior to that of index funds. One possible explanation of why investors buy actively managed open end funds lies in the fact that they are bought and sold at net asset value, and thus management ability may not be priced. If management ability exists and it is not included in the price of open end funds, then performance should be predictable. If performance is predictable and at least some investors are aware of this, then cash flows into and out of funds should be predictable by the very same metrics that predict performance. Finally, if predictors exist and at least some investors act on these predictors in investing in mutual funds, the return on new cash flows should be better than the average return for all investors in these funds. This article presents empirical evidence on all of these issues and shows that investors in actively managed mutual funds may have been more rational than we have assumed.
The Effect of Morningstar Ratings on Mutual Fund Flows, Working Paper, Federal Reserve Bank of
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Diane Del Guercio and Paula A. Tkac, Star Power: The Effect of Morningstar Ratings
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