Active return
In
Benchmark portfolios are often represented in theoretical contexts to include all investment assets - sometimes called a market portfolio in these contexts, but is in practice a subset of practically available investable assets.[3] In those cases where the benchmark or the market portfolio include all investable assets, active management is a zero-sum game, as no group of active managers can achieve positive active returns over the benchmark portfolio without another group of managers taking the other side of those positions and producing negative active returns; active managers as a whole in this case cannot outperform the market portfolio.[4]
In a simple arithmetic return attribution, if denotes the return for the portfolio and denotes the return for the benchmark, then a simple active return is given by , and can be either positive or negative.[5]
Active return in the context of Brinson models
Active return in the context of CAPM
Active return is often studied in the context of CAPM, the
These predictions imply that one may measure active returns relatively easily: a linear regression of the excess returns of a portfolio against a consensus market excess return. Such a linear regression produces an estimated alpha (or intercept), and an estimated beta on market excess returns. Assuming all CAPM assumptions hold in the particular context, the estimated beta of the market portfolio excess return is the CAPM beta, the residual (assumed to be zero in a linear regression) represents the residual return in CAPM, and alpha represents active returns achieved through active management of the portfolio.[11] CAPM implies that changing the beta of a portfolio to time for periods of high market portfolio returns, a type of market timing, cannot achieve active returns, since in the CAPM context active return is defined as return in excess of market portfolio returns. The assumptions of CAPM also point to ways for active management to achieving active return, which involves investing on information not yet incorporated into the consensus around the market portfolio.[12]
Uses of Active Return
Measurements of active return play a big role in investment manager evaluation, compensation, and selection.[13] Active return forecasts are an input into portfolio return forecasts, which are crucial inputs in investment planning and asset-liability management. Portfolio managers could examine active returns to evaluate which active decisions or types of active decisions have succeeded in their portfolios, to allocate resources (personnel, dollar budgets, risk budgets, etc.) to implement different active decisions, and to communicate with fund sponsors about portfolio performance.
Uses from the perspective of fund sponsors
Fund sponsors typically look for proficiency, consistency, and precision in the ability of active portfolio investment managers to produce active returns. A portfolio's scale of active returns implies a manager is proficient in producing active returns, its repeatability of active returns over time implies a manager is consistent at producing active returns, and its conformity of its sources of active returns with the manager's stated investment objectives implies a manager is precise in producing active returns. Fund sponsors typically choose a number of investment managers and allocate them assets to manage; they could compare these qualities of active returns among different investment managers to adjust allocations to their mandates.[14]
Uses form the perspective of investment managers
In cases where investment managers pursue multiple investment strategies in a single portfolio, such as fund of funds or multi-strategy portfolios, investment managers could use qualities of active returns of particular strategies to shift resources between investment strategies in the portfolio much like how fund sponsors would shift allocations between investment managers.[15] The active return and active risk of individual investment strategies can be used to calculate information ratio, which can be used to allocation investment strategies, and/or individual investments in assets, such as stocks, in a portfolio to maximize total portfolio active return.[16]
See also
- Active risk
- Information ratio
- Tracking error
References
- Brinson, Gary P., and Nimrod Fachler, “Measuring Non-US Equity Portfolio Performance,” Journal of Portfolio Management, Spring 1985, pp. 73-76.
- Brinson, Gary P., Randolph Hood, and Gilbert Beebower, “Determinants of Portfolio Performance,” Financial Analysts Journal, 1986, vol. 42, no. 4(July-August), pp. 39-44.
- ^ Bacon, Carl R. (2019). "Performance Attribution History and Progress". CFA Institute Research Foundation. p. 18. Retrieved 2020-05-15.
- ^ Grinold, Richard C.; Kahn, Ronald N. (1999). Active Portfolio Management: A Quantitative Approach for Producing Superior Returns and Selecting Superior Returns and Controlling Risk (2 ed.). McGraw-Hill. p. 1,7,12.
- S2CID 153107814.
- ^ Clarke, Roger G.; de Silva, Harindra; Thorley, Steven (2015). "Analysis of Active Portfolio Management". CFA Institute. p. 3. Retrieved 2020-05-15.
- ^ Bacon, Carl R.; Wright, Marc A. (2012). "Return Attribution". CFA Institute. Retrieved 2020-05-10.
- ^ "Return Attribution". CFA Institute. 2012. Retrieved 2020-05-11.
- ^ Bacon, Carl R.; Wright, Marc A. (2012). "Return Attribution". CFA Institute. Retrieved 2020-05-10.
- ^ Steiner, Andreas (2012). "Active Risk Attribution". Retrieved 2020-05-11.
- ^ Grinold, Richard C.; Kahn, Ronald N. (1999). Active Portfolio Management: A Quantitative Approach for Producing Superior Returns and Selecting Superior Returns and Controlling Risk (2 ed.). McGraw-Hill. p. 18.
- S2CID 153107814.
- ^ Fama, Eugene F.; French, Kenneth R. (2004). "The Capital Asset Pricing Model: Theory and Evidence" (PDF). p. 44. Retrieved 2020-05-13.
- S2CID 153107814.
- ^ Urwin, Roger (1998). "Avoiding disappointment in investment manager selection" (PDF). International Association of Consulting Actuaries, March 1998. Retrieved 2020-05-11.
- ^ Bacon, Carl R.; Wright, Marc A. (2012). "Return Attribution". CFA Institute. p. 334. Retrieved 2020-05-10.
- ^ Bacon, Carl R.; Wright, Marc A. (2012). "Return Attribution". CFA Institute. p. 334. Retrieved 2020-05-10.
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