On the Negative Performance Puzzle: Positive Alpha and Investor Value

40 Pages Posted: 5 Jan 2019 Last revised: 4 Jun 2019

See all articles by Ali Kakhbod

Ali Kakhbod

Massachusetts Institute of Technology (MIT) - Department of Economics

Maziar Kazemi

Massachusetts Institute of Technology (MIT)

Date Written: April 2019

Abstract

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

Kakhbod, Ali and Kazemi, Maziar, On the Negative Performance Puzzle: Positive Alpha and Investor Value (April 2019). Available at SSRN: https://ssrn.com/abstract=3304762 or http://dx.doi.org/10.2139/ssrn.3304762

Ali Kakhbod

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Maziar Kazemi (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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