Consistent Alpha

Despite numerous studies (including Jensen: 1968, Blake, Elton Gruber: 1993, Mark Carhart: 1997, and James Davis: 2000) that indicate lackluster performance of active portfolio management, the industry maintains growth, albeit more slowly. One such study, “The Arithmetic of Active Management”, written by William F. Sharpe (1991), makes the case that “(1) before fund costs, the return on the average actively managed dollar will be equal the return on the average passively managed dollar and, (2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.” In summary, Sharpe asserts that active managers in aggregate effectively hold securities representing the index and therefore cannot outperform a passive strategy after costs. Whilst the conclusion is certainly damning, the word “aggregate” is in fact much more telling and should be read as some active managers do well and others do not.

Given all the anomalies and variables within the industry, performance analysis remains difficult and inconclusive (e.g. aligned benchmarks, adjusting for survivor bias, and using a time period spanning complete market cycles), therefore in relation to performance concerns, the importance of greater due diligence in manager selection is the only unequivocal observation that can be actioned.

By Louay Al-Doory