Contract Evaluation Horizon and Fund Performance

Abstract

Mutual funds face the risk of withdrawals if they perform poorly in the short term, which encourages manager myopia. We show that fund families can insulate managers from this funding pressure via compensation tied to long-term fund performance. Managers with long-horizon contracts are more likely to undertake long-term investments and outperform their constrained peers. Since long-horizon pay does not shut off the funding pressure, it simply insulates the manager from it, not all families can offer these contracts. Long-horizon contracts are more prevalent in families that cater to patient investors and have more resources to buffer liquidity shocks.

Presented by Veronika K. Pool.