Portfolio management in the Italian mutual fund industry: an interview survey.

AuthorBolognesi, Enrica
  1. INTRODUCTION

    A wide number of studies, focused on portfolio management, has thoroughly investigated the main drivers explaining the performance obtained by mutual funds (i.e. transaction costs, investment strategies, fund size, portfolio managers skills and incentive schemes). However, the mainstream literature on mutual funds has devoted very little attention to the way the management company is structured and how this structure affects investment strategies and performance (Massa and Zhang, 2009). At first sight, the organizational structure of an AM company can appear quite basic because, in most cases, it is characterized by a low level of hierarchy. In reality, even in the presence of a flat structure, the internal organization of these companies is sophisticated because it must ensure a balance between operational flexibility (essential to allow for an active portfolio management and a value creation) and the risk management. In other words, the organizational structure and the set of internal operational procedures must be carefully defined so as to achieve, contextually, two primary objectives of the firm which are the performance maximization and the control of the risks taken by portfolio managers.

    This paper aims to investigate the internal dynamics of AM companies focusing on the main elements affecting the portfolio management in the Italian industry, which is one of the major player in the European fund market. Organizational models have been the subject of a great deal of literature, mainly of an empirical nature and aimed at analysing the existing relationship between the decision making process inside an organisation and the effectiveness of the management's choices (see Dean and Sharfman, 1996). The larger the company, and therefore the more complex the company hierarchy, the more elaborate the decision making process which creates organisational diseconomies (Williamson, 1988). In accordance, Stein (2002) argues that, in the presence of hierarchy costs, small organisations ought to outperform large ones at tasks that involve the processing of soft information. This study firstly focuses on the analysis of the investment decision-making process because of its strategic importance in determining the asset allocation of the managed funds. Portfolio management is therefore limited by a set of constraints, identified by the risk management unit, designed to control the managers' behaviour.

    Another important aspect, examined in this study, concerns the presence of in-house research divisions. The costly investment in this unit is motivated by its support to fund managers in the stocks selection and in the investment strategies. This division is of a strategic nature for asset managers if we consider that the bottom-up investment style is largely adopted in fund management. In alternative, research reports are offered by brokerage companies (sell-side research) in addition with other services linked to the portfolio management (i.e. stock negotiation and organization of analysts meetings). In this case, fund managers must be aware of the potential conflict of interests between investment companies and listed firms (see Ramnath et al., 2008 for a survey on this issue).

    The analysis of the internal procedures in these companies proceeds with the investigation of the set of parameters influencing the fund managers' compensation schemes. On this topic, agency theory is concerned with solving two problems that can occur in agency relationships. The first is the problem that arises when the desires or goals of the principal and agent conflict which can make it difficult and/or expensive for the principal to verify what the agent is actually doing. The second is the problem of risk sharing that arises when the principal and agent have different attitudes towards risk. These problems have been largely analysed in relation to portfolio management (Jensen and Meckling, 1976; Grinblatt and Titman, 1989, Ross, 2004). Focusing on the AM industry, Massa and Patgiri (2008) argue that incentives increase fund managers' efforts determining a higher risk-adjusted performance. In particular, they show that high-incentive funds outperform low-incentive funds and that the superior performance cannot be explained solely by higher risk taking. Instead, superior performance relates to increases in managers' efforts which makes outperformance persistent. The present study identifies the excess return on the benchmark and the competition against the peers the main objective for the fund managers showing a high heterogeneity of the weight of these parameters between the companies.

    Finally, this analysis focuses on the importance of the time horizon in the portfolio management. Time horizon is a central variable in influencing investment choices made by any economic agent. For fund managers, their time horizon falls on the 31st of December every year, the date when the performance of the fund is registered and the annual bonus is calculated. One of the problems of this practice is the fact that the end of the year can influence the portfolio managers' investment choices which may lead to misleading effects in the portfolio asset allocation. Many studies have focused on this issue. Brown et al. (1996) argue that the tournament structure of the mutual fund industry influences the asset managers to vary the risk level of their portfolios near the end of the valuation period. This result is also provided by Chevalier and Ellison (1997) which demonstrate that funds alter their portfolios between September and December in a manner consistent with the September incentive to take risk calculated from the flowperformance relationship. Moreover, the importance of the year-end for most of the decision makers inside a firm is the main reason of the so called short-termism (see Demirag, 1998). Based on a survey analysis of the UK mutual funds managers, Baker (1998) demonstrates that the holding period of the shares held in institutional portfolios (used as a short-termism proxy) is inversely correlated to both the frequency of performance monitoring as well as to the proportion of performance related pay to total pay. On this topic, this research investigates the fund managers' opinion about the impact of the year-end deadline on the decision making.

    The present study is based on an interview survey that involved the main fund managers operating in Italy. This methodological choice is motivated by the descriptive framework of some of the analysis carried out. One-to-one interviews also guarantee a great reliability of the data as well as the completeness of the database. The sample of interviewees is composed of 21 equity fund managers working in the 10 major Italian AM companies. The purpose of this study, being the investigation of the elements influencing portfolio management at the firm level, means the analysis limited to the major players is appropriate. Moreover, the Italian industry is characterized by a high concentration of the investment fund market in a few large domestic groups. In fact, the Asset under Management (AuM) of the 10 firms within the sample represented nearly 77% of the overall AuM in Italian open-end funds. This data confirms the evidence provided by Bengtsson and Belbecque (2011) of the high concentration of the Italian industry where the 5 largest fund management companies hold a market share of 52% of the total fund market. Another point to highlight is the high level of homogeneity of this sample because it is composed solely of managers responsible of equity mutual funds invested in a specific geographical area, therefore characterized by the same operational rules (i.e. stated investment strategies, performance taxation, financial leverage and regulatory constraints).

    Prior research, based on surveys, has focused on the AM industry with the aim to examine specific aspects of the portfolio managers' behaviour. Based on an interview survey on a sample of 64 fund managers specialized in the UK equity market, Baker (1998) investigates the relationship between performance evaluation and fund managers' attitude to risk, motivation and time horizon. Arnswald (2001), Menkhoff et al. (2006) and Lutje (2009) conducted surveys on the German AM industry. In particular, Arnswald (2001), focusing on a sample of 278 questionnaire, investigates the fund managers' beliefs and practices as well as their company's performance measurement and compensation incentives. Menkhoff et al. (2006)...

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