Happy Losers : Subcontracting in International Asset Management

We study international outsourcing in the asset management industry. We argue that subcontractor management companies use the funds they manage on behalf of third parties to subsidize their own inhouse funds. On average, inhouse funds outperform the outsourced funds by 7.5 basis points per month. We attribute this difference in performance to within-company subsidization and identify risk-taking as the main source of the observed performance differentials. Portfolios of inhouse funds are 5-8% more illiquid, load 5% more on the market factor, and score consistently higher in the within-style tournament. Inhouse funds engage in performance-improving cross-trading with affiliated outsourced funds. The trades between inhouse and outsourced funds of the same company are more illiquid than outside trades. Inhouse funds use outsourced funds as insurance at the time of distress; a one standard deviation increase in the fraction of outsourced funds managed by the same company mitigates the negative performance impact of large outflows of an inhouse fund by up to 30%. However, outsourcing families still benefit from outsourcing even after subsidization. We endogenize the outsourcing decision and we see that, via outsourcing, fund families mitigate the negative effects of being located far away and improve expected return by 31.2 bp a month on average. This suggests that outsourcing is used as a means of overcoming segmented equity markets