Joint Meeting of the Mid-Atlantic and Northeast Regions

Implications of Advisory Fee Structure for Fair Valuation in Bond Mutual Funds

• In Event: Audit and Advisory Fees

Abstract

I explore the risk-taking implications of advisory fee structures. Mutual
funds compensate their investment advisors with fees based on assets-under-management
(AUM). The fees can be either linear or concave functions of AUM. While prior literature
on equity mutual funds finds that advisors with a more linear fee structure engage in more
risk-taking, I find the opposite in bond mutual funds: they assume less risks. This
noteworthy difference is likely because bond mutual fund advisors have a greater incentive
to avoid AUM decline than to grow AUM, and those with a more linear fee structure have
an even greater incentive to do so. Further, I find that the negative association between fee
linearity and risk-taking is increasing in fund importance, redemption risk, and market
uncertainty. My findings suggest that the dynamics of the relation between advisory fee
structure and risk-taking in bond mutual funds differ from those in equity mutual funds.

Author

• Minjae Koo, Chinese University of Hong Kong