The Value and Price of Active Management
Wells Fargo Funds Management
December 26, 2009
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, G24working papers series
Date posted: December 27, 2009
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