People see high returns in a particular sector, and they cannot tell whether the lower returns they are receiving are due to their fund manager’s proper avoidance of risk, or incompetent management. As they increasingly conclude that incompetence is to blame, funds shift to the new sector and this creates a self-reinforcing process where prices are driven above their fundamental values, i.e. a bubble occurs. It seems like such reallocation of investment funds could, if driven by a strong enough incentive, be enough on its own to drive a bubble even without an external source of liquidity.

Capital market booms and crashes, culminating in the latest sorry and socially costly crisis, have discredited the idea that markets are efficient and that prices reflect fair value.
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Theory has ignored the real world complication that investors delegate virtually all their involvement in financial matters to professional intermediaries – banks, fund managers, brokers – who dominate the pricing process.

Delegation creates an agency problem. Agents have more and better information than the investors who appoint them, and the interests of the two are rarely aligned.
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he new approach offers a more convincing interpretation of the way stock prices react to earnings announcements or other news. It also shows how short-term incentives, such as annual performance fees, cause fund managers to concentrate on high-turnover, trend-following strategies that add to the distortions in markets, which are then profitably exploited by long-horizon investors. At the level of national markets and entire asset classes, it will no longer be acceptable to say that competition delivers the right price or that the market exerts self-discipline.