Evaluating Absolute Return Managers

17 Pages Posted: 1 Oct 2013

See all articles by Momtchil Pojarliev

Momtchil Pojarliev

Fischer Francis Trees & Watts, Inc.

Richard M. Levich

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: September 22, 2013

Abstract

One traditional measure of investment performance, the Information Ratio (IR), is defined as the active return (alpha) divided by the tracking error (the standard deviation of the active return). Calculating an IR is straightforward when the benchmark for performance is a buy-and-hold standard like the S&P 500. For absolute return managers, however, the typical benchmark we observe is zero meaning that any excess return is classified as alpha and deemed to represent the return from active management or skill. In this paper, we argue that this standard approach confuses beta returns and alpha returns. The former can be earned by following generic strategies that can be easily implemented and are often replicated by ETFs while the later are associated with more original or complex strategies that more genuinely reflect unique skills or expertise. We propose a new performance metric that strips out beta returns associated with investment style factors. This approach leads to a new statistic, the alpha ratio, which can dramatically impact the relative performance rankings of managers and provide a clearer signal of manager skill.

Keywords: Hedge Funds, Alpha and Beta Separation, Style Investing

JEL Classification: F21, F31, G11, G23

Suggested Citation

Pojarliev, Momtchil and Levich, Richard M., Evaluating Absolute Return Managers (September 22, 2013). Available at SSRN: https://ssrn.com/abstract=2333210 or http://dx.doi.org/10.2139/ssrn.2333210

Momtchil Pojarliev

Fischer Francis Trees & Watts, Inc. ( email )

200 Park Avenue, 11th Floor
New York, NY 10166
United States

Richard M. Levich (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0422 (Phone)
212-995-4256 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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