This study focuses on the value of active versus passive portfolio management emphasizing on whether the average active manager is capable of generating superior risk-adjusted returns (i.e., alpha) in the future. The authors use a style-classified sample of mutual funds to focus on ways in which investors can select active managers with the best chance of producing superior subsequent investment returns. The analysis contains three main findings. First, they calculate the empirical distributions of both historical and forecasted risk-adjusted performance measures for the fund sample. These alpha statistics indicate that while the median manager does not match return expectations on either a backward- or forward-looking basis, a considerable percentage of the managers do exceed that hurdle. Second, they present evidence revealing several tractable relationships between an observable set of fund characteristics and the fund’s subsequent investment performance. An important factor considered was the funds’ past performance, which is consistent with the notion that superior performance tends to persist over time and the level of its expense ratio.
The authors use a selection process that controls these factors to explain how investors can significantly increase their probability of selecting an active manager whose future risk-adjusted returns will exceed expectations. The study also demonstrates the considerable economic advantage enjoyed by an investor who employs this selection process. This evidence strongly suggests that superior active managers do exist and that investors have a reasonable chance of finding them. Further, the study also underlines that once they identify and select these superior managers, investors are rewarded for their efforts. According to the study, this leads to two implications: (i) there is a place in an investor’s portfolio... [continues]
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