Portfolio Oversight: An Evolutionary Approach

Abstract

An analogue can be made between: (a) the slow pace at which species adapt to an environment, which often results in the emergence of a new distinct species out of a once homogeneous genetic pool, and (b) the slow changes that take place over time within a fund, with several co-existing investment style which mutate over time.

A fund’s track record provides a sort of genetic marker, which we can use to identify mutations. The biometric procedure presented here can detect the emergence of a new investment style within a fund’s track record.

In doing so, we answer the question: “What is the probability that a particular PM’s performance is departing from the reference distribution used to allocate her capital?”

Keywords: Skewness, Kurtosis, Mixture of Gaussians, Moment Matching, Maximum Likelihood, EM algorithm

JEL Classification: C01, C02, C15, C16, C38, C44