AGENTS WITH CONFLICTS
To be sure, the study sheds no light on whether the underperformance also represents an underperformance against the markets themselves or a broader universe of funds. The promise, or selling proposition, of side-by-side management has been as a talent retention and attraction mechanism for fund managers, who've argued that mutual fund clients can benefit by getting access to managers who might otherwise leave them for the greener pastures of the hedge fund industry.
One thing is clear: those managers who do side-by-side management can earn a disproportionate part of their compensation, all else being equal, from the hedge fund side.
An earlier study found that for each incremental dollar earned by hedge fund investors, the typical manager expects a 16 cent reward from incentive fees and the increase in value of their managerial ownership stake. That same dollar of incremental return also drives 23 cents in prospective reward for managers in the form of inflows and growth in future investments. That latter figure is as much as eight times higher than the rewards a mutual fund manager might expect.
The study did find, however, that managers for whom mutual fund money represents an above-median proportion of their funds under management did not display the same lag in performance.
"Managers are presumably reluctant to shift performance away from the mutual fund if poor performance is likely to result in significant outflows and potential career consequences," according to the study.
While the study does show underperformance, it does not demonstrate how this happens, though the SEC has taken proceedings in past against managers for "cherry picking," where more profitable trades are allocated to favored clients.
While investors may simply choose not to invest in mutual funds with side-by-side management, the real need is for better regulation to provide assurance that clients are treated fairly.