Winning at Active Management

Chapter 2 Culture in Investment Management

Investment managers present a puzzle to understanding the prospective value of their work, even when compared to other services business. The measurement of portfolio performance has evolved considerably in the past 30 years: evaluated against a particular benchmark, the wisdom of a manager’s past decisions can be analyzed in great detail, with a galaxy of custom- designed statistics.

That said, portfolio mathematics still have trouble in definitively distinguishing luck from skill in historical results (particularly over short periods). Even the most skillful active managers sometimes underperform their benchmarks, and less skilled managers can be blessed with lucky streaks. A great active manager might outperform 60 percent of the time, but still underperform during the other 40 percent (and in truly challenging market environments, such as the one following the global financial crisis, it’s likely that many active managers will fall short).

Even more challenging is the prediction of future performance from the results of the past: some of the earliest research from financial academics went in search of predicting performance, although its success has been fleeting. One early example is the Sharpe ratio, proposed 50 years ago by Stanford professor William Sharpe, initially as a tool for forecasting the returns of mutual funds.¹ More recently, the financial economists Martijn Cremers and Antti Petajisto hit on a new statistic that ...