DP17042 Strategic Asset Allocation under Peer Group Benchmarks
In the managed fund industry, compensation is performance-based and is evaluated with respect to a benchmark. The benchmarks can be an exogenous absolute index or the performance of comparable funds. We analyze the impact of a convex compensation scheme based on peer-group benchmarks. We develop a model of tournament between risk- averse fund managers who receive a fee proportionally to the return differential between their fund and the benchmark, provided that they beat the benchmark. We find that a more competitive benchmark leads to more risk-taking and more differentiated investment strategies. A more competitive (larger) industry provides similar incentives.