Wednesday, June 21, 2006

Assessing Investment Manager Skill

BestInvest concludes that "the success of only 11% of 1562 UK asset managers can be attributed to skill". They measure managers outperformance vs. an appropriate risk adjusted index. They then subtract the probability of this result being achieved by chance. Financial Times

The probability of a managers excess return being due to chance or skill can be indicated by its T-statistic. The t statistic is a measure of how extreme a statistical estimate is. You compute this statistic by subtracting the benchmark return from the calculated risk adjusted return and then dividing by the estimated standard error.

There is an indication that the managers results may be the result of luck or random chnace when the t-statistic is close to zero. Alternately, manager skill may be indicated when the t-statistic is large positive. Finally, there may be an indication that the manager has consistently lost value when the t-statistic is large negative.

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