Delegated Portfolio Management and Rational Prolonged Mispricing

Abstract

This paper examines how information becomes reflected in prices when investment decisions are delegated to fund managers whose tenure may be shorter than the time it takes for their private information to become public. We consider a sequence of managers, where each subsequent manager inherits the portfolio of their predecessor.We show that the inherited portfolio distorts the subsequent manager's incentive to trade on long-term information. This allows erroneous past information to persist, causing mispricing similar to a bubble.We investigate the magnitude of the mispricing. In addition, we examine endogenous information quality. In some cases, information quality increases when the manager's expected tenure decreases. MORE THAN EVER BEFORE, investors delegate the management of their investment portfolios to professional fund managers. 1 Due to mobility and turnover, the expected tenure of a manager may be shorter than the investment horizon of a typical investor. 2 Given this horizon mismatch, fund managers may have less incentive to collect and trade on long-term information than do the investors they trade for. As a result, the prices in markets with more delegated investment will reflect less long-term information than those markets where long-lived investors manage their own portfolios. The amount of long-term information that is reflected in prices is likely also to change with market conditions. As a manager's

Institutional Investment Constraints and Stock Prices

“…Edelen, Ince, and Kadlec (2014) document that institutions are on the wrong side of anomalies more often than not. Goldman and Slezak (2003) show that delegated portfolio management may distort managers' incentive to trade on long-term information and cause stock mispricing. It seems a fruitful venue for future research to explore further how issues arising from delegated portfolio management affect money managers' portfolio decisions and stock prices in equilibrium, following the lead of Roll (1992), Carpenter (2000), Cornell and Roll (2005), Cuoco and Kaniel (2011), and others.…”

The relationship between pension funds and the stock market: Does the aging population of Europe affect it?

“…Certain works support the notion that institutional investors help to achieve market efficiency (Barber, Lee, Liu, & Odean, 2009;Boehmer & Kelley, 2009;Griffin, Harris, & Topaloglu, 2003); however, other authors find the opposite result (Brunnermeier & Nagel, 2004;Dow & Gorton, 1997;Zeng, 2016). The long-term nature of pension funds may improve market efficiency, but managers may lose the incentive to apply long-term strategies because it takes longer to reveal their private information than allowed for by their tenure (Goldman & Slezak, 2003). Additionally, periodic performance scrutiny, competition among managers (Abreu & Brunnermeier, 2002, and concerns about future careers (Hong, Scheinkman, & Xiong, 2008), may all force managers to invest in overvalued assets with high past returns, producing prolonged stock mispricing.…”

Pension Fund Manager Tournaments and Attitudes Towards Corporate Characteristics

“…One consequence of the growing importance of institutional investment is that the control of corporate stock has been increasingly concentrated into the hands of a relatively small number of professional fund managers who determine how institutional funds are invested. This change has sparked considerable interest regarding the role that fund manager skills play in shaping fund performance (e.g., Brown et al, 1997) and the extent to which professional portfolio managers adapt their investment behaviour to the economic incentives they are provided (Dow and Gorton, 1997; Goldman and Slezak, 2003; and Blake et al, 2002). Conceptual and empirical research has begun to investigate these incentive structures.…”