Tuesday, August 22, 2006

A New Investment Measure that Predicts Performance

Martijn Cremers and Antii Petajisto from the Yale School of Management are on to something with their study entitled How Active Is Your Fund Manager? A new Measure that Predicts Performance. Their notion that active investment management decisions should be bifurcated and measured differentially by both stock selection and factor timing (aka market timing) correlates well with how the consultant community tries to measures active manager performance. The study suggets that funds whose alpha source is stock selection outperform funds that generate alpha by sector timing and funds that are closet indexers. The authors introduce a measure they call Active Share which indicates how different a funds stock holdings are from its benchmark index and therefore how actively the fund is managed. Based on what appears to fairly rigorous statistical analysis, the active share measure appears to have a unique relationship with fund performance and demonstrates some persistence over time. According to this study, funds with the smallest stock overlap with their benchmark(ie stockpicker), the smallest assets and the best 1 year performance seem attractive, outperforming their benchmarks by 6% per year. This study appears to advance academic work on active management though the calculations are based on fund holdings which can make repetitive use uneconomical.

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