tailieunhanh - Risk Taking by Mutual Funds as a Response to Incentives

In general, you’ll have to pay tax on the money you make on a fund. Interest, dividends and capital gains are all treated differently for tax purposes and that will affect your return from an investment. Keep in mind that distributions are taxable in the year you receive them, whether you get them in cash or they are reinvested for you. However, if you hold your mutual funds in a registered plan, you won’t pay income tax on the money you make as long as that money stays in the plan. When you withdraw money from the plan, it will. | Selected Paper Number 77 Risk Taking by Mutual Funds as a Response to Incentives Judith Chevalier and Glenn Ellison An agency problem exists when one person the agent is hired to act as on the behalf of another person the principal and their interests diverge so that the agent acts in ways that are not in the best interests of the principal. One example is the relationship between the investors and managers of a mutual fund. Investors would like the fund to maximize risk-adjusted returns. Mutual fund companies however are motivated by their own profits. Further the information they possess and how they use it are not directly observable by investors. As a result if actions that maximize fund company profits differ from actions that maximize investor risk-adjusted returns we would expect the fund to choose the actions that maximize profits. Most fund companies receive a percentage of fund assets as compensation. Articles in the press often argue that fund companies have poor incentives to maximize returns for investors since fund compensation isn t explicitly tied to fund performance. But obviously funds do face a powerful implicit performance incentive since the fund company s fees depend on the size of its assets the fund company s income rises when new investment flows into the fund and falls when investment flows out. This is true as long as the fund company s costs do not rise at a greater rate than its assets. Most accounts of the fund industry suggest that costs do rise more slowly than assets except possibly for the very largest funds. This implicit incentive should work well. New investments flow into funds that perform well while investment flows out of funds that perform poorly. Actions that lead to investment inflows will also tend to be actions that increase risk-adjusted returns for investors. When this is the case there is no conflict. However the fund s goal of asset inflow and the investor s goal of maximizing returns may sometimes be in conflict. .

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