Tuesday, January 15, 2013

Short-sale Constraints and the Pricing of Managerial Skills: The Case of Mutual Funds

CHENG Si, MASSA Massimo, ZHANG Hong
Read the working paper
INSEAD Working Paper 2013/06/FIN revised version of 2012/92/FIN

One salient feature of the mutual fund industry is that investors cannot short-sell funds. We argue that this has a profound impact on the pricing of managerial skills. In the presence of different opinions on managerial skills, managers can charge fees higher than the value (performance) that they deliver. This fee strategy allows funds to price discriminate and to attract only the most optimistic capital, which helps to explain a list of stylized observations and puzzles in the mutual fund industry, including the underperformance of active funds, the existence of flow convexity, and the negative correlation between gross-of-fee α and fees.