Institutional Setting

Abstract

In order to understand the performance determinants of active mutual funds in the cross-section and over time it is important to analyze their institutional setting in an integrated framework (Figure 1.1). Fund performance not only depends on the skills of the fund manager, but it is also related to the efforts of the fund manager and the actions of the investment management company and investors. First of all, frictions in the economy result in transaction costs and asymmetric information. On the one hand, this offers the opportunity to generate abnormal returns based on superior investment skills. On the other hand, a need for delegation follows from these frictions, especially for small retail investors. In large part, this stems from economies of scale in information production and the reduction of transaction costs, both of which reduces the costs from market frictions for small investors. Thus, investors should theoretically benefit from delegated active management.