Separating Portfolio Performance into Opportunity, Foresight, and Active Management Risk

37 Pages Posted: 15 Jul 2010 Last revised: 6 Dec 2011

See all articles by Kenneth Khang

Kenneth Khang

Idaho State University

Thomas W. Miller

Mississippi State University - College of Business; Saint Louis University - Department of Finance

Date Written: November 15, 2011

Abstract

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

Khang, Kenneth and Miller, Thomas William, Separating Portfolio Performance into Opportunity, Foresight, and Active Management Risk (November 15, 2011). Available at SSRN: https://ssrn.com/abstract=1640202 or http://dx.doi.org/10.2139/ssrn.1640202

Kenneth Khang (Contact Author)

Idaho State University ( email )

921 South 8th Avenue
Pocatello, ID 83209
United States

Thomas William Miller

Mississippi State University - College of Business ( email )

Mississippi State, MS 39762-0964
United States

Saint Louis University - Department of Finance ( email )

3674 Lindell Blvd
Saint Louis, MO 63108-3397
United States
314-977-3851 (Phone)
314-977-1479 (Fax)

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