Portfolio Design: A Modern Approach to Asset Allocation

PERFORMANCE ACROSS MANAGERS

Managers are not created equal. That’s true of any asset class where active management is pursued since managers differ in their abilities to select assets. But it’s especially true of hedge funds. The performance of managers varies widely because different strategies are pursued. But the dispersion in performance across managers is much too large to be explained by whether one strategy, such as market-neutral equity, is chosen rather than another, like fixed-income arbitrage. Generating alpha is not easy, especially not the large alphas that are found for some hedge funds.

To investigate the dispersion in manager performance, it’s helpful to compare hedge funds with other types of investments. That’s exactly what Malkiel and Saha (2004) did in the working paper version of the study cited earlier. Using TASS data for hedge fund managers and Lipper data for mutual fund managers, they calculated the returns of the top quartile and third quartile managers for each of five asset classes. These were hedge funds and four types of mutual funds for real estate, international equity, U.S. equity, and U.S. fixed income. Figure 9.5 reports the excess returns of the first quartile and third quartile managers over the median manager for that asset class. Thus in the case of U.S. equity mutual funds, the top quartile manager delivered 0.9 percent more than the median manager while the third quartile manager delivered 0.5 percent less than the median manager. For hedge ...