Incentive Fees and Competition in Pension Funds: Evidence from a Regulatory Experiment in Israel

Abstract

Regulators worldwide take the view that competition - and not performance-based fees - should play a dominant role in aligning the interests of retirement savings fund managers with those of their clients. We use a regulatory experiment from Israel to examine the effects of incentive fees and competition on performance. Taking advantage of a unique institutional setup, we compare three exogenously-given types of retirement savings funds operated by the same management companies: (i) funds where fees are performance-based; (ii) funds where fees are based on assets under management (AUM) operating in an environment with very weak competitive pressures; and (iii) funds where fees are AUM-based and the environment is highly competitive. We find that funds with performance-based fees exhibit high returns, high risk and high α. By contrast, when comparing the average performance of funds with AUM-based fees in competitive and less competitive environments, we find no significant differences (except that funds in a competitive environment charge lower fees). We conclude that incentives and competition are not perfect substitutes in the retirement savings industry. We also conjecture that the ubiquitous regulatory restrictions on the use of incentives in fund management may be inefficient, and should perhaps be reconsidered.

Keywords: Competition, Incentives, Pension Funds, Retirement Savings

JEL Classification: G23, G28, G38