Competition in Portfolio Management: Theory and Experiment

We explore theoretically and experimentally the general equilibrium price and allocation implications of delegated portfolio management when the investor-manager relationship is non-exclusive. Investors transfer their securities allocations to managers, managers trade in a competitive marketplace to achieve new allocations, and payo↵s are distributed back to investors after subtraction of a portfolio management fee. Our theory predicts that competition forces managers to promise portfolios that mimic Arrow-Debreu (AD) securities, which investors then combine to fit their preferences. As such, individual manager portfolios do not match investor preferences, but certain combinations will, and consequently, prices in the inter-manager market still reflect investor preferences. In particular, state prices (relative to state probabilities) implicit in prices of traded securities will be inversely ranked to aggregate wealth across states, which means that a weak version of the Capital Asset Pricing Model (CAPM) obtains, as in a world without delegated portfolio management. Our experiment broadly corroborates the price and choice predictions of the theory. However, pricing quality deteriorates when only a few managers end up attracting most of the available wealth. Fund concentration increases because funds flow towards managers who o↵er portfolios closer to replicating AD securities (as in the theory), but also because funds flow to managers who had better performance in the immediate past (an observation unrelated to the theory).