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CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition by CAIA Association

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32.8 QUANTITATIVE ANALYSIS OF MANAGERS

According to Burghardt and Walls (2011), the research on sources of risk and return to CTAs has important implications for those who perform due diligence or evaluate portfolios for a living. However, obtaining relevant information through research has its challenges. First, because luck dominates skill over the kinds of horizons that investors usually work with, track records are very weak tools for evaluating the performance of a manager (running a portfolio of strategies) or a fund of funds (running a portfolio of managers). Therefore, historical track records produce imperfect estimates when used to approximate the statistical properties of returns needed to determine portfolio weights. As a result, there are serious limits on what investors can hope to accomplish by reviewing track records of investment managers. Second, once portfolios are formed, the ensuing track records produce sampling errors that make it very hard to determine whether the manager was selected successfully. It can be argued that short-term to medium-term track records tell us essentially nothing about the way a trader or investor makes money. However, investors often cannot afford to wait four or five years for the longer-term results needed to make reasonably good evaluations. Therefore, qualitative research regarding a manager's trading strategy, including its foundations, plays a critical role in manager selection process.

The limitations regarding track records ...

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