From the abstract of “Money Doctors”, in the February issue of the Journal of Finance,
We present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor’s perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust, fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average underperform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs.
And more gems inside,
In particular, an investor would prefer to make a given investment with the manager he trusts most, enabling that manager to charge the investor a higher fee and still keep him. Even if managers compete on fees, these fees do not fall to costs, and substantial market segmentation remains. In fact, in our model, fees are proportional to expected returns, with higher fees in asset classes with higher risk and return. Net of fees, investors consistently underperform the market, but experience less anxiety and earn higher expected returns than they would by investing on their own. A very simple formulation based on trust thus delivers some of the basic facts about money management that the standard approach finds puzzling.
Read it all here.