The Industrial Organization of Money Management

We construct and analyze a model of delegated portfolio management in which money managers signal their investment skills via their choice of transparency for their fund. We show that a natural equilibrium is one in which high- and low-skill managers pool in opaque funds, while medium-skill managers separate in transparent funds. In this equilibrium, high-skill managers rely on their eventual performance to separate from low-skill managers over time, saving the monitoring costs associated with transparency. In contrast, medium-skill managers rely on transparency to separate from low-skill managers, especially when it is difficult for investors to tell them apart through performance alone. Low-skill managers prefer mimicking high-skill managers in opaque funds in the hope of replicating their performance and compensation. The model yields several novel empirical predictions that contrast transparent funds (e.g., mutual funds) and opaque funds (e.g., hedge funds).