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Much of portfolio theory has ignored the investment decisions of fund managers despite their important role as financial intermediaries or agents. This study employs agency theory to study the behaviour of UK portfolio managers towards risks. Conventional portfolio theory suggests that there should be a clientele effect. That is, funds with real and long term liabilities should specialise in riskier assets whilst those with nominal and short term liabilities specialise in less risky assets. We find little evidence of such a clientele effect based on a study of the portfolio compositions of four investing institutions: pension funds, life insurance companies, unit trusts and investment trusts. The absence of a clientele effect may be due to the limitation of conventional portfolio theory, which is mostly single-period. We examine the theory's implications for fund management in a more general multiperiod setting. To some extent, our findings are able to reconcile the discrepancy between theory and practice. Agency theory argues that fund managers may become asymmetrically averse to downside risks when their performance are competitively evaluated over short intervals. As a result, herding behaviour may occur. That is, managers may mimic the portfolio decisions of other managers to avoid grossly underperforming the average fund. We find evidence in agreement with agency theory, based on a cross-sectional study of pension funds and life insurance companies. Agents may also mimic the trading decisions of other managers over time. Studies of asset volatilities have indirect bearing on this temporal portfolio behaviour. If contemporaneous trading takes place with little reference to information signals, asset prices become excessively volatile in relation to these signals. Using the volatility test of Kleidon(1986) and co integration tests for speculative bubbles (Engle and Granger 1987), we investigate whether the UK stock market has been excessively volatile relative to the present value of expected dividend flows. The evidence are against the hypothesis of excessive volatility, and suggest that herding behaviour did not have a pervasive influence on UK share prices. |
