The Value and Price of Active Management

Abstract:     
This paper establishes an arbitrage pricing framework for evaluating how valuable fund managers really are. This simple framework allows for an investor to determine whether a manager is over or underpaid by looking at the relationship between the manager’s up-capture and down-capture ratio. The relationship depends on the risk-free rate of return and the expected return on the benchmark portfolio in an “up-state” and a “down-state.” Because of this state dependence and dependence on investor perceptions of market opportunities, a manager who is overpaid in one environment may be underpaid or fairly paid in another environment. Depending on the investor’s expectations, a manager may be more or less valuable. The value of active management is, thus, context and investor dependent.

Number of Pages in PDF File: 6

Keywords: active management, portfolio management, arbitrage pricing, risk-neutral pricing, mutual funds

JEL Classification: G00, G11, G12, G24

working papers series