Analyzing Active Investment Strategies
Posted: 19 Jul 2007
For investors it is important to know what trading strategies an asset manager pursues to generate excess returns. In this paper, we propose an alternative approach for analyzing trading strategies used in active investing. We use tracking error variance (TEV) as a measure of activity and introduce two decompositions of TEV for identifying different investment strategies. To demonstrate how a tracking error variance decomposition can add information, a simulation study testing the performance of different methods for strategy analysis is conducted. In particular, when investment strategies contain random components, TEV decomposition is found to deliver important additional information that traditional return decomposition methods are unable to uncover.
Keywords: tracking error, tracking error variance, decomposition, active investment strategies
JEL Classification: G11
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