The Intelligent Enterprise in the Era of Big Data

CHAPTER 6 FINDING ALPHA IN FINANCIAL MARKETS

6.1 Introduction

Active managers (mutual funds, hedge funds) are constantly looking to find inefficiencies in the markets. How do they find such inefficiencies? They use a variety of strategies and factors to construct their portfolios. All such strategies and factors are based on the understanding and insight of their research staff using the information they are able to process.

The effectiveness of an active management strategy clearly depends on the skills of the manager and the research staff. The conventional wisdom based on the The Standard and Poor's Index Versus Active (SPIVA) quarterly scorecards was that only a small number of actively managed mutual funds have gains better than the SPIVA benchmark. However, recent research (Brooks, 2001) shows that actively managed funds outperform benchmarks if we were to look more closely at the active portion of these portfolios. This suggests a clear informational value.

A recent historical study of active versus passive investing (Hartford Funds, 2015) points out that active management has typically outperformed passive management during market corrections. The study argues that active and passive management have moved in cycles. In certain cycles with high levels of dispersion and volatility, active managers have tended to outperform passive managers. In periods with low levels of dispersion, vice versa has been true.

We believe, however, that today's active manager is handicapped ...