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0 comments / 19/02/2015 /

THE RIGHT ANSWER TO THE WRONG QUESTION: IDENTIFYING SUPERIOR ACTIVE PORTFOLIO MANAGEMENT

W. V. Harlow and Keith C. Brown

The debate over the value of active portfolio management has often centered on whether the average active manager is capable of producing returns that exceed expectations. We argue that a more useful way to frame this issue is to focus on identifying those managers who are the most likely to generate superior risk-adjusted returns (i.e., alpha) in the future. Using a style-classified sample of mutual funds, we document several tractable relationships between observable fund characteristics and its future alpha, most notably the tendency for performance to persist over time. While median managers produce positive risk-adjusted performance approximately 45% of the time, we document a selection process that improves an investor’s probability of identifying a superior active manager to almost 60%. We conclude that there is a place in the investor’s portfolio for the properly chosen active manager.

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