(February 20, 2013) — The intersection between asset management and investment banking is not without conflicts, according to an academic paper released by three university professors.
Using data from 1990 to 2008, the analysis compares the alphas of mutual funds, hedge funds, and institutional funds operated by investment banks and non-bank conglomerates. The authors defined “conglomerates” as large organizations that are not investment banks whose primary business is running portfolios for a wide variety of investors. “We find that while there is no difference in performance by fund type, being owned by an investment bank reduces alphas by 46 basis points per year in our baseline model,” write the authors, Janis Berzins of BI Norwegian Business School, Crocker Liu from Cornell University, and Indiana University’s Charles Trzcinka. “Making lead loans increases alphas but the dispersion of fees across portfolios decreases alphas. The economic loss is $4.9 billion per year.”
The paper concludes: “The harm is largely borne by mutual fund investors and depends on the fee dispersion across portfolios offered by the investment bank and the participation of the investment bank in lead loans during the year. It does not depend on equity or debt underwriting business. The greater the fee dispersion, the more the harm; the more the participation in lead loans the lower the harm.”
More specifically, the researchers found that the effect of investment bank ownership is material amounting to at least $93 billion loss over the 19 year sample but the dollar loss is time-varying. For 14 years of the 19 year sample, the costs of being owned by a bank were higher than the benefits. There were only five years–1993- 1994 and 2001-2003–where the benefits of being owned by an investment bank outweighed the costs.
As noted by the authors, the many potential conflicts of interest for investment banks are typically accompanied by a variety of mechanisms that aim to control the impact of conflicts of interest. “The question of whether the mechanisms actually control conflicts is ultimately an empirical one. We examine this question by testing whether diversification of activities within financial institutions adds value to assets under management due to information links or subtracts value due to conflicts of interest,” the paper concludes.
According to the researchers, the study raises the question of why investment banks are able to extract such sizable economic rents. A partial answer to this question may be in the time variation of the rents. The authors noted that perhaps five years of adding value conditioned investors enough to hold off the competition from non-bank conglomerates in the 14 years the investment banks subtracted value. “The ability to do so suggests that bank competition in fund management is an important area for future research,” the paper suggests.
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