Are Mutual Fund Investors Paying for Noise?

62 Pages Posted: 16 Mar 2015 Last revised: 6 May 2015

See all articles by Lorenzo Casavecchia

Lorenzo Casavecchia

University of Technology Sydney

Hardy Hulley

University of Technology, Sydney (UTS) - Finance Discipline Group; Financial Research Network (FIRN)

Date Written: March 26, 2015

Abstract

We demonstrate that advisory fees exhibit a positive concave dependence on the idiosyncratic volatilities of mutual fund returns. Our theoretical analysis attributes this to the impact of idiosyncratic noise on performance opacity, coupled with the infeasibility of short-selling mutual fund shares. Echoing the literature on the principal-agent model for executive compensation, we show that previous estimates of the fee-performance sensitivity for mutual funds are negatively biased, since they do not account for the impact of idiosyncratic noise on fees and performance. Finally, we show that investor sophistication reduces the dependence of advisory compensation on idiosyncratic noise.

Keywords: Advisory fees, idiosyncratic noise, short-selling constraints

JEL Classification: C72, D58, D83, G11, G12, G23

Suggested Citation

Casavecchia, Lorenzo and Hulley, Hardy, Are Mutual Fund Investors Paying for Noise? (March 26, 2015). FIRN Research Paper No. 2578547, Available at SSRN: https://ssrn.com/abstract=2578547 or http://dx.doi.org/10.2139/ssrn.2578547

Lorenzo Casavecchia

University of Technology Sydney ( email )

8 Ultimo Rd
Sydney, NSW 2007
Australia

Hardy Hulley (Contact Author)

University of Technology, Sydney (UTS) - Finance Discipline Group ( email )

Haymarket
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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