On the Negative Performance Puzzle: Positive Alpha and Investor Value
40 Pages Posted: 5 Jan 2019 Last revised: 4 Jun 2019
Date Written: April 2019
We propose a parsimonious equilibrium model of active managers and investors. We allow feedback effects from optimal fee-setting by managers on the expected mean returns of the manager benchmark. We show that using a standard model of the SDF from the negative performance puzzle literature, that alpha will be positive when managers add value over the benchmark asset. However, we also show that the sign of alpha is not sufficient for determining investor value, but that alpha needs to exceed some positive threshold to determine whether the existence of managers is value improving for investors. In empirical exercises, we show that this cutoff is non-trivial, and that a number of U.S. domestic equity mutual funds fall on either side of the line.
Keywords: Active Management, Negative Performance Puzzle, Pricing Kernel
JEL Classification: G23, G21, G11
Suggested Citation: Suggested Citation