Optimal Decentralized Investment Management





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    • Binsbergen is at the Graduate School of Business, of Stanford University; Brandt is at the Fuqua School of Business, of Duke University, and Koijen is at Tilburg University. Brandt is also associated with the NBER, and Koijen is also associated with Netspar. We thank Suleyman Basak, Phil Dybvig, Simon Gervais, Cam Harvey, Frank de Jong, Ron Kaniel, Theo Nijman, Anna Pavlova, Antonios Sangvinatsos, Hans Schumacher, Rob Stambaugh (the editor), Stijn Van Nieuwerburgh, Dimitri Vayanos, Sunil Wahal, Bas Werker, an anonymous referee, and seminar participants at ABP Investments, Duke University, Tilburg University, the 2006 EFA meetings, and the 2007 AFA meetings for helpful comments and suggestions. Jules van Binsbergen thanks the Prins Bernhard Cultuurfonds for generous financial support.


We study an institutional investment problem in which a centralized decision maker, the Chief Investment Officer (CIO), for example, employs multiple asset managers to implement investment strategies in separate asset classes. The CIO allocates capital to the managers who, in turn, allocate these funds to the assets in their asset class. This two-step investment process causes several misalignments of objectives between the CIO and his managers and can lead to large utility costs for the CIO. We focus on (1) loss of diversification, (2) unobservable managerial appetite for risk, and (3) different investment horizons. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. We find that the CIO's uncertainty about the managers' risk appetites increases both the costs of decentralized investment management and the value of an optimally designed benchmark.