We study outsourcing relationships among international asset management firms. We find that in companies that manage both outsourced and inhouse funds, inhouse funds outperform outsourced funds by 0.85% annually (57% of the expense ratio). We attribute this result to preferential treatment of inhouse funds via the preferential allocation of IPOs, trading opportunities and cross-trades, especially at times when inhouse funds face steep outflows and require liquidity. We explain preferential treatment with agency problems: it increases with the subcontractor's market power and the difficulty of monitoring the subcontractor and decreases with the subcontractor's amount of parallel inhouse activity.
We use the merger of BlackRock with Barclays Global Investors (BGI) as an event to study how changes in ownership concentration affect the investment behavior of financial institutions and the cross-section of stocks worldwide. We find that other institutional investors re-balance away from stocks that experience a large increase in ownership concentration due to the pre-merger portfolio overlap between BlackRock and BGI. Over the same period, institutional ownership migrates towards comparable stocks not held by BGI funds prior to the merger. The re-allocation of institutional ownership has price impact. Stocks that experience large increases in ownership concentration due to the merger experience negative returns that do not fully revert. These stocks also become permanently less liquid and less volatile. We argue that the merger is exogenous with respect to the characteristics of the stocks held by BGI funds prior to the merger. This allows for a causal interpretation of the results and points to strong strategic complementarities associated with large, global asset management firms that may lead to financial fragility. We speculate that financial fragility is driven by fear of future, possibly idiosyncratic firm events and not necessarily by actual firm events per se.
This paper received some media coverage from Ignites
, Fund Fire
, The Business Times Singapore
, and Manager Magazin
My co-author Massimo Massa
was interviewed on the paper by CNBC
We study consolidation in the global asset management industry. The merging companies benefit from the merger via two channels: access to new markets and to new investment expertise. While the performance of acquiror-affiliated funds deteriorates during the merger process (mainly driven by declining returns in the acquiror's main areas of expertise), the target funds' performance improves. Following the deal, acquiror and target companies shift the relative intensity of new fund launches towards new distribution markets, generating higher flows in new funds launched there. In addition, both acquiror- and target-affiliated funds converge in their portfolio compositions after gaining a common affiliation. Specifically, acquiror (target) funds begin investing in areas where the target (acquiror) used to invest prior to the merger, and generate outperformance in those newly-entered investments. Our results indicate that mergers allow acquirors to address their deteriorating performance because they allow acquirors to capture new flows both directly (via target distribution channels) and indirectly (via learning about new investment areas).
This paper received some media coverage from 929
We study the link between information barriers in global markets and the organizational form of asset management. Fund families outsource funds in which they are at an informational disadvantage to generate performance. Using a structural model of self-selection, we endogenize the outsourcing decision and estimate positive gains from outsourcing of around 9-14 bps per month despite the ex-post underperformance of outsourced funds vis-à-vis in-house funds. The gains from outsourcing provide a novel proxy for the information barriers that segment global financial markets. The more segmented the underlying markets where the funds invest, the larger the gains from outsourcing.
- Home Bias Abroad: Domestic Industries and Foreign Portfolio Choice
In their foreign portfolios, international mutual funds overweight industries that are comparatively large in their domestic stock market. This Foreign Industry Bias is akin to a “Home Bias Abroad” and explains between 13% and 47% of foreign benchmark deviations. The bias is associated with superior performance primarily driven by stockpicking within foreign industries by funds with a simultaneous “Home Bias” in the domestic portfolio. Such funds outperform foreign market indices and active local country funds when investing in large domestic industries abroad. The results suggest that domestic stock market compositions proxy for the comparative advantages of international investors when they invest abroad.
- Contagion and Decoupling in Intermediated Financial Markets
I analyze the interplay between fundamental and intermediation risk in a multi-asset dynamic general equilibrium model with heterogeneous agents. Agents differ in their level of direct access to investment opportunities. Intermediation relationships are formed to overcome limited market access. Intermediation risk is captured via frictions in the relationships between agents that introduce fragility into asset prices. Asset prices are fragile when they have a concentrated investor base making them dependent on the fortunes of a few investors. In contrast, a non-concentrated investor base makes asset prices resilient with respect to intermediation risk. But not all assets with a concentrated investor base are fragile. I identify fundamental characteristics that induce resilience in assets with a common concentrated investor base. These characteristics lead to portfolio rebalancing within the common investor base that makes some assets resilient and renders others fragile in the presence of intermediation risk. Likewise, in a multi-asset framework, assets that are resilient due to a broad investor base are not completely immune to the fragility experienced by other assets. In a dynamic context, fragile assets tend to experience contagion whereas resilient assets tend to decouple whenever the intermediation frictions are severe. I argue that an understanding of the dynamic behavior of asset prices requires an understanding of fundamental and intermediation risk as well as the interaction between the two.