Allison and Bill are both mutual fund managers, although Allison is more skilled than Bill. Both have $100 million in assets under management and charge a fee of 1%/year. Allison is able to generate a 2% alpha before fees and Bill is able to generate a 1% alpha before fees.

a. What is the net alpha investors earn in each fund (that is, the alpha after fees are taken out)?

b. Which fund will experience an inflow of funds?

c. Assume that both managers have exhausted the supply of good investment opportunities and so they will choose to invest any new funds received in the market portfolio and so those new funds will earn a zero alpha. How much new capital will flow into each fund?

d. Once the new capital has stopped flowing in, what is the alpha before and after fees of each fund? Which fund will be larger?

e. Calculate each manager’s compensation once the capital has stopped flowing. Which manager has higher compensation?

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