Mutual Fund Risk-Shifting and Management Contracts   (PDF)

We find evidence that risk‐shifting by mutual fund managers is linked to their asymmetric performance‐based compensation. We show that managers whose mid‐year performance is close to their announced benchmark increase their portfolio risk in the second part of the year. As their performance deviates from the benchmark, their risk‐shifting decreases except for the most extreme deviations. We find that the deviation from the benchmark dominates the incentives from the flow‐performance relationship, supporting the conclusion that risk‐shifting is based more on management contracts than on a tournament to capture flows.