The John M. Olin Center

Paper Abstract

74. John Abraham, Breaking Down Asset Managers: Active and Passive Fund Incentives for Anti-Competition, 05/2017.

Abstract: Large asset managers house trillions of dollars in savings and have led to a dramatic concentration of capital. In two recent papers, Azar, Schmalz and Tecu and Azar, Raina and Schmalz have presented potential evidence that these large asset managers reduce incentives for competition among portfolio companies.

This paper raises doubts about the Azar et al. formulation. The principal question this paper seeks to address is whether or not monopolistic-outcomes among competing portfolio companies are necessarily in the best interest of large asset managers. If such “soft competition” is not in their best interest financially, it would be hard to see how or why large asset managers would induce monopoly behavior. To answer the question, the paper breaks down large asset managers and examines the financial incentives of their two primary businesses: actively and passively managed funds. In short, both fund types are incentivized to maximize assets under management, and not returns. Active funds compete in a market where relative performance, not absolute returns, determines fund inflows and thus profits. Thus they do not desire maximum returns from all portfolio companies. Further, the aggregate portfolio of assets held in passive funds differs substantially across asset managers. The varying portfolios in turn imply that different portfolio managers desire different types of competition among portfolio firms. Finally, because these large firms comprise hundreds or thousands of individual funds, their incentives are complex and difficult to predict, even for themselves, with regard to competition in specific markets. In conclusion, while the authors have triggered important research about the effects of large asset managers in capital markets, looking closely at the interworking of the firms themselves reveals serious reasons to doubt incentives for anti-competition exist.

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