Asset Management within Commercial Banking Groups: International Evidence

• DOI: http://doi.org/10.1111/jofi.12702
• Author: PEDRO PIRES,PEDRO MATOS,MIGUEL A. FERREIRA
• Published date: 01 October 2018
• Date: 01 October 2018

THE JOURNAL OF FINANCE •VOL. LXXIII, NO. 5 •OCTOBER 2018

Asset Management within Commercial Banking

Groups: International Evidence

MIGUEL A. FERREIRA, PEDRO MATOS, and PEDRO PIRES∗

ABSTRACT

We study the performance of equity mutual funds run by asset management divisions

of commercial banking groups using a worldwide sample. Weshow that bank-affiliated

funds underperform unaffiliated funds by 92 basis points per year. Consistent with

conflicts of interest, the underperformance is more pronounced among those affili-

ated funds that overweight the stock of the bank’s lending clients to a great extent.

Divestitures of asset management divisions by banking groups support a causal inter-

pretation of the results. Our findings suggest that affiliated fund managers support

their lending divisions’ operations to reduce career concerns at the expense of fund

investors.

MUTUAL FUND COMPANIES MANAGE TRILLIONS of U.S. dollars worldwide, but many

of these companies are not stand-alone entities. About 40% of mutual funds

are run by asset management divisions of groups whose primary activity is

commercial banking. This phenomenon is less prevalent in the United States

(only 20% of mutual funds) as a result of the Glass-Steagall Act, which sepa-

rated banking and asset management activities for many decades. Since the

repeal of Glass-Steagall by the Gramm-Leach-Bliley Act in 1999, many U.S.

∗Miguel A. Ferreira is at the Nova School of Business and Economics, CEPR, and ECGI. Pedro

Matos is at the University of Virginia–Darden School of Business, and ECGI. Pedro Pires is at

the Nova School of Business and Economics. We thank Kenneth Singleton (the Editor), the Asso-

ciate Editor, two anonymous referees, Claire Celerier, Lauren Cohen, Richard Evans, Benjamin

Golez, Peter Hoffmann, Russell Jame, Bige Kahraman, Andrew Karolyi, Alberto Manconi, Saurin

Patel, Melissa Prado, Ruy Ribeiro, David Schumacher, Clemens Sialm, and Rafael Zambrana;

participants at the American Finance Association Annual Meeting, European Finance Association

Annual Meeting, Financial Intermediation Research Society Annual Conference, McGill Global

Asset Management Conference, Recent Advances in Mutual Fund and Hedge Fund Research

Conference–ESMT Berlin, and Luxembourg Asset Management Summit; and seminar participants

at the Darden School of Business, Federal Reserve Board, Georgia State University, International

Monetary Fund, Luso-Brazilian Finance Network (Lubrafin), Maastricht University,Norges Bank

Investment Management, Nova School of Business and Economics, U.S. Securities and Exchange

Commission, Stockholm School of Economics, Southern Methodist University, Telfer Annual Con-

ference on Accounting and Finance, TempleUniversity, Texas A&M University, Tilburg University,

University of Alabama, University of Hong Kong, University of Toronto, and VillanovaUniversity

for helpful comments. Financial support from the European Research Council (ERC), the Fundac¸˜

ao

para a Ciˆ

encia e Tecnologia (FCT), and the Richard A. Mayo Center for Asset Management at the

Darden School of Business is gratefully acknowledged. We have read the Journal of Finance’s

disclosure policy and have no conflicts of interest to disclose.

DOI: 10.1111/jofi.12702

2181

2182 The Journal of Finance R

banking groups have begun to develop asset management divisions. Press re-

ports indicate that bank-affiliated funds often underperform funds operated by

independent fund management companies, particularly in Europe.1Yet, aca-

demic research has little to say about the potential spillover effects between

commercial banking and asset management divisions.

When fund management companies are owned by commercial banking

groups, fund managers may benefit the bank’s lending business at the ex-

pense of fund investors (conflict of interest hypothesis).2Alternatively, the

lending business may generate private information about borrowers via credit

origination, monitoring, and renegotiation that is beneficial to the affiliated

fund manager (information advantage hypothesis). A third possibility is that

banking groups impose “Chinese walls” to prevent communication between the

asset management and lending divisions, so that funds operate independently

of other bank divisions (null hypothesis).

We test these hypotheses using a comprehensive sample of open-end equity

mutual funds domiciled in 28 countries over the period 2000 to 2010. We focus

on actively managed funds that invest in domestic equities because banks

typically have stronger lending relationships with domestic firms. We define

commercial bank-affiliated funds as those funds that belong to a management

company that is either majority-owned by a commercial parent bank or part

of a group that owns a commercial bank. The other management companies

are classified as affiliated with investment banks or insurance companies or as

unaffiliated companies.3

We find that, on average, commercial bank-affiliated funds underperform

unaffiliated funds by about 92 basis points per year as measured by four-factor

alphas. We obtain similar results when we use alternative measures of per-

formance such as benchmark-adjusted returns, gross returns, or buy-and-hold

returns. In addition, we find that affiliated funds underperform more when

the ratio of outstanding loans to assets under management is higher, which is

consistent with greater conflicts of interest. When we examine cross-country

differences in the performance of affiliated funds, we find that “Chinese walls”

between bank lending and asset management activities are more strictly en-

forced and fund investors’ rights are better protected in common-law countries

such as the United States (Khorana, Servaes, and Tufano (2005,2009)). In the

sample of U.S.-domiciled funds, we find less pronounced underperformance and

no relation between performance and measures of conflicts of interest with the

lending division.

To examine more directly whether the parent bank’s lending activity is di-

rectly linked to fund underperformance, we measure the overlap between lend-

ing clients and fund stock holdings using the bank’s activity in the syndicated

1See Steve Johnson, “Bank-run funds are poor performers,” Financial Times, January 9, 2011.

2See Mehran and Stulz (2007) for a review of the literature on conflicts of interest in financial

institutions.

3We focus on the conflict of interest within commercial banking groups because net interest

income represents the largest share of revenues among top banks worldwide.

Asset Management within Commercial Banking Groups 2183

loan market. A “client stock” is a firm that obtained a syndicated loan from

the bank during the previous three years and whose shares are held in the

portfolio of a fund affiliated with the bank. We show that bank-affiliated funds’

portfolio holdings are biased toward client stocks over nonclient stocks. In addi-

tion, we find that bank-affiliated funds with higher portfolio exposure to client

stocks (in excess of the portfolio weights in passive funds that track the same

benchmark) tend to underperform more.

The endogeneity of the organizational form of a management company makes

it difficult to identify a causal effect. The decision to operate a fund management

company as bank affiliated may be related to unobserved fund characteristics

that also explain the performance. We implement two empirical strategies

to address this concern. First, we use fund fixed effects to control for time-

invariant unobserved fund heterogeneity. The estimated underperformance of

affiliated funds is even more pronounced in this case, which indicates that per-

formance deteriorates after a fund switches from unaffiliated to bank-affiliated.

Second, we exploit the exogenous variation generated by divestitures of asset

management divisions by commercial banking groups during the 2000 to 2012

period as well as in the aftermath of the 2007 to 2009 financial crisis, when

banks improved their regulatory capital ratios by divesting asset management

units.4The evidence shows that funds that switch from affiliated to unaffil-

iated through divestiture subsequently reduce their holdings of client stocks

and experience improved performance.

One remaining concern with our results is that bank-affiliated funds might

hire less skilled fund managers. We examine the portfolio trading of affil-

iated funds using calendar-time portfolio returns. In these tests, we com-

pare manager skill exclusively within affiliated funds on their holdings of

client and nonclient stocks. We find that funds that overweight client stocks

to a greater extend underperform in the trading of client stocks. However,

these funds do not underperform in the trading of nonclient stocks. More-

over, funds that overweight client stocks to a lesser extent do not underper-

form in the trading of client stocks. These results do not support the skill

hypothesis.

Why do commercial bank-affiliated funds exist in equilibrium if they perform

more poorly? We try to understand the motivation of the different agents by

providing evidence on the benefits that accrue to the parent bank and fund

manager, as well as to the borrower. First, we show that banks use affili-

ated fund resources to build lending relationships with borrowers (Bharath

et al. (2007,2011), Ferreira and Matos (2012)). We find that banks are more

likely to act as lead arrangers of future loans when they exert control over

borrowers by holding shares through their asset management divisions; these

holdings increase the probability of initiating a lending relationship and pre-

serving a past lending relationship. Second, we find that fund managers that

act as team players for their banking group by overweighting client stocks

are less likely to lose jobs. This result suggests that career concerns help

4See “Find management–Wasting assets,” The Economist, January 18, 2009.