Optimum Centralized Portfolio Construction with Decentralized Portfolio Management

Abstract

Many financial institutions employ outside portfolio managers to manage part or all of their investable assets. These institutions include pension funds, private endowments (e.g., colleges and charities), and private trusts. In 1999, the investment company institute estimated that these institutions managed 5.2 trillion dollars in assets. Most of these institutions employed outside managers to invest these funds. The relevancy of this problem has been widely recognized in the practitioners literature on portfolio. Furthermore, it is recognized in the prudent man law that spells out the responsibilities of the centralized decision maker delegating management responsibility.2 For example the New York State law in estate power and trust states. Pension funds are the largest and most likely organizations to employ several outside managers, each of whom manages a part of the overall portfolio. In this paper we will use the pension fund manager as the prototype of the centralized decision-maker trying to optimally manage a set of decentralized portfolio managers but the analysts is general.