Are You The Source Of Alpha For Your Competitors’ Portfolios?

Surprise! An investor’s ability to make superior forecasts is not enough, if their portfolio is to deliver positive alpha.

“Most portfolio decision makers should go out of business – take up plumbing, teach Greek or help produce the annual GNP by serving as corporate executives.” This was the opinion of Paul Samuelson back in 1974. The debate around the value provided by active management is not new and will most probably continue to rage in various guises over time. It has become even more vigorous in today’s low-return environment, where the growth in portfolio market values is not enough to soften the impact of portfolio management fees. What often goes unsaid during these debates is the impact that poor benchmark design and inappropriate risk budgeting has on the performance of active managers.

Modern portfolio theory states that, in the long run, investors should expect to be rewarded for taking on more market risk. For example, in the long run investors should expect a higher return (risk premium) for investing in equities and not cash. Unfortunately, the same relationship does not hold when it comes to active risk. Active risk is the process of building an investment portfolio where the weights of the individual securities are different from the market.

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