Hypercube in the Kitchen: Reading a Menu of Active Investment Strategies

Abstract

Active investment management is crucially dependent on skill, i.e. the ability to deliver consistent outperformance. All types of unique investment skill form a space. Understanding a basis of this space helps build portfolios of active strategies. We propose one such basis by representing an arbitrary investment process as an abstract information processing system. The obtained 5-dimensional skill-based classification is meant to complement existing classifications. Its purpose is to assist investors in better understanding a menu of available investment strategies as well as to help asset managers to position themselves on that menu. We provide a detailed discussion of a risk premia related dimension of our proposed basis arguing that risk premia strategies require special skills.

Keywords: Active Investment, Alpha-beta Separation, Arbitrage, Efficient Market, Fund Classification, Information Processing System, Investment Skill, Investment Process, Mispricing, Risk Premia

JEL Classification: G11, G12, G14, G15, G23, D81