New Developments in Long-Term Asset Management

Supported by Norges Bank Investment Management
Monika Piazzesi and Luis Viceira, Organizers
Fourth Annual Conference
Cambridge, MA

May 9-10, 2019

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The Benchmark Inclusion Subsidy

By Anil K Kashyap, Natalia Kovrijnykh, Jian Li, and Anna Pavlova

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Common Ownership in America: 1980-2017, Matthew Backus, Christopher Conlon, and Michael Sinkinson

Valuing Private Equity Investments Strip by Strip, Arpit Gupta, and Stijn Van Nieuwerburgh

Which Investors Matter for Global Equity Valuations and Expected Returns? Ralph S. J. Koijen, Robert J. Richmond, and Motohiro Yogo

The Impact of Pensions and Insurance on Global Yield Curves, Robin Greenwood, and Annette Vissing-Jorgensen

What's Wrong with Pittsburgh? Delegated Investors and Liquidity Concentration, Andra C. Ghent

Conditional Dynamics and the Multi-Horizon Risk-Return Trade-off, Mikhail Chernov, Lars A. Lochstoer, and Stig Lundeby

Fund Tradeoffs, Lubos Pastor, Robert F. Stambaugh, and Lucian A. Taylor

The Subsidy to Infrastructure as an Asset Class, Aleksandar Andonov, Roman Kräussl, and Joshua Rauh

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The asset management industry has been growing rapidly and is currently estimated to control more than $85 trillion worldwide. Most of this money is managed against benchmarks. For instance, S&P Global reports that, in 2017, assets under management (AUM) managed against the S&P 500 alone reached nearly $10 trillion. We study the effects of evaluating asset managers relative to a benchmark on corporate decisions, e.g., investments, M&A, spinoffs, and IPOs. We introduce asset managers into an otherwise standard model and show that firms inside the benchmark are effectively subsidized by the asset managers. This “benchmark inclusion subsidy” arises because asset managers have incentives to hold some of the equity of firms in the benchmark regardless of their risk characteristics. Due to the benchmark inclusion subsidy, a firm inside the benchmark values an investment project more than the one outside. The same wedge arises for valuing M&A, spinoffs, and IPOs. For example, for M&A we show that a merger of a firm in the benchmark with a firm outside creates value for stockholders.

Our findings are in contrast to the standard result in corporate finance that the value of an investment is independent of the entity considering it. We fully characterize the benchmark inclusion subsidy, which and allows us to predict the situations when it is the most and least important. We show that the higher the cash-flow risk of an investment and the more correlated the existing and new cash flows are, the larger the subsidy. The subsidy is zero for safe projects. The subsidy also increases with AUM managed against the benchmark and with market risk aversion. In addition, we show that a reallocation of AUM following the benchmark from active to passive strategies increases the subsidy. Finally, we find that investment projects whose cash flows are positively correlated with those produced by firms in the benchmark are valued higher. As a consequence, cash flows in the economy with asset managers endogenously become more homogeneous/correlated with each other.

Our estimates of the reduction of the cost of capital owing to the benchmark inclusion range from 30 basis points to a full percentage point for S&P 500 firms. We review a host of empirical evidence that is consistent with the model's implications.

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