Impact of Changes in Benchmark Constituents on Portfolio Delegation

In delegated management, it is common practice to manage portfolios within specific risk tolerances based on benchmark indices. We provide insights into the fund manager’s optimal learning and investment behavior in response to changes in constituents of the benchmark. Our model allows us to examine the importance of allocating attention to newly listed stocks. The manager’s optimal effort exerted by the manager on new stock decreases as the constraint on tracking error becomes tighter. On the other hand, the optimal effort allocated to the new stock increases as the size of delegated funds increases. It is advisable to loosen the tracking error limits for delegated fund managers from the perspective of investor’s wealth under changes in benchmark constituents.