Why Constrain Your Mutual Fund Manager?
Andres Almazan
Keith C. Brown
David A. Chapman
Abstract
We examine the form, adoption rates, and economic
rationale for the investment restrictions found in the contracts between mutual
fund investors and managers. Based on a sample of U.S. domestic equity funds
from 1994 to 2000, we find systematic patterns in the use of policy constraints
that are consistent with an optimal contracting view of fund industry.
Restrictions are more frequently present when it is relatively less beneficial
to use direct methods to monitor manager behavior, including when (i) boards
contain a higher proportion of inside directors, (ii) the portfolio manager is
more experienced, (iii) the fund is managed by a team rather than an
individual, and (iv) the fund does not belong to a large organizational
complex. We find no evidence that low- and high-constraint funds produce
different risk-adjusted returns, which is also consistent with the existence of
a contracting equilibrium.
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