Portfolio Pumping, Trading Activity and Fund Performance

Abstract

We develop a model of trading by an informed fund manager compensated on the basis of her fund's Net Asset Value ( NAV ). We show that she has an incentive to pump her portfolio by buying securities she already holds. Pumping leads to excessive trading and hurts long-term fund performance. It also biases upward measured NAV s and contributes to closed-end fund discounts. Despite such costs, it may still be optimal to base her compensation on NAV .