Equilibrium Prices in the Presence of Delegated Portfolio Management∗

The paper analyzes the asset pricing implications of performance fees linking the compensation of fund managers to the return of the managed portfolio relative to that of a benchmark portfolio. Symmetric (“fulcrum”) performance fees distort the allocation of managed portfolios in a way that induces a significant positive effect on the equilibrium prices of stocks included in the benchmark portfolio, a significant negative effect on their equilibrium Sharpe ratios, and an economically insignificant positive effect on their equilibrium volatilities: these implications of the model are consistent with the available empirical evidence. On the other hand, asymmetric performance have a significant impact on equilibrium volatilities and the sign of differentials in the equilibrium stock prices, Sharpe ratios and volatilities of stocks included in or excluded from the benchmark portfolio fluctuates stochastically over time.