Separating Portfolio Performance into Opportunity, Foresight, and Active Management Risk
37 Pages Posted: 15 Jul 2010 Last revised: 6 Dec 2011
Date Written: November 15, 2011
We introduce a decomposition showing precisely how actively-managed portfolio returns can be separated into three measurable components that we call Opportunity, Foresight, and Active Management Risk. Opportunity reflects the degree to which the investment opportunity set contains exploitable asset returns. Foresight and Active Management Risk reflect how well a manager forecasts relative asset returns for the next period and how aggressively a manager changes portfolio weights at the start of the period. Using simulated weights, we show that our measures have the power to detect even modest levels of predictive ability. They also can disentangle predictive ability and aggression. We apply the decomposition to asset allocation recommendations from a set of Investment Houses. We find little Foresight, but considerable Active Management Risk.
Keywords: Portfolio Performance Measurement, Portfolio Performance Decomposition, Unconditional Performance, International Investment Houses, Asset Allocation
JEL Classification: G12, G14, G23
Suggested Citation: Suggested Citation