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Economists’ hubris — the case of equity asset management

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  • Shojai, Shahin

    ()
    (Capco)

  • Feiger, George

    ()
    (Contango Capital Advisors)

  • Kumar, Rajesh

    ()
    (Institute of Managment Technology)

Abstract

In this, the fourth article in the economists’ hubris paper series, we look at the contributions of academic thought to the field of asset management. We find that while the theoretical aspects of the modern portfolio theory are valuable, they offer little insight into how the asset management industry actually operates, how its executives are compensated, and how their performances are measured. We find that very few, if any, portfolio managers look for the efficiency frontier in their asset allocation processes, mainly because it is almost impossible to locate in reality. They seem to base their decisions on a combination of gut feelings and analyst recommendations. We also find that the performance evaluation methodologies used are simply unable to provide investors with the necessary tools to compare portfolio managers’ performances in any meaningful way. We suggest a novel way of evaluating manager performance which compares a manager against himself, as suggested by Lord Myners. Using the concept of inertia, an asset manager’s end of period performance is compared to the performance of their portfolio assuming their initial portfolio had been held, with-out transactions, during this period. We believe that this will provide clients with a more reliable performance comparison tool and might prevent unnecessary trading of portfolios. Finally, given that the performance evaluation models simply fail in practice, we suggest that accusing investors who look for raw returns when deciding who to invest their assets with is simply unfair.

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Bibliographic Info

Article provided by Capco Institute in its journal Journal of Financial Transformation.

Volume (Year): 29 (2010)
Issue (Month): ()
Pages: 9-16

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Handle: RePEc:ris:jofitr:1421

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Related research

Keywords: Asset management; Fund management; Modern Portfolio Theory; Performance evaluation models; Efficient Market Hypothesis;

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References

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  1. Dizdarevic, Predrag & Shojai, Shahin, 2004. "Integrated data architecture — the end game," Journal of Financial Transformation, Capco Institute, vol. 11, pages 62-65.
  2. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  3. Hunter, Greg, 2009. "Anatomy of the 2008 financial crisis: an economic analysis postmortem," Journal of Financial Transformation, Capco Institute, vol. 27, pages 45-48.
  4. Boudoukh, Jacob, et al, 1997. "Pricing Mortgage-Backed Securities in a Multifactor Interest Rate Environment: A Multivariate Density Estimation Approach," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 405-46.
  5. Shojai, Shahin, 2009. "Economists' Hubris - The Case of Mergers and Acquisitions," Journal of Financial Transformation, Capco Institute, vol. 26, pages 4-12.
  6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  7. Frank Fabozzi & Vinod Kothari, 2007. "Securitization: The Tool of Financial Transformation," Yale School of Management Working Papers amz2495, Yale School of Management, revised 01 Jul 2007.
  8. Hand, David & Yu, Keming, 2009. "Justifying adverse actions with new scorecard technologies," Journal of Financial Transformation, Capco Institute, vol. 26, pages 13-17.
  9. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  10. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  11. Shojai, Shahin & Feiger, George, 2009. "Economists’ hubris – the case of asset pricing," Journal of Financial Transformation, Capco Institute, vol. 27, pages 9-13.
  12. Keith Kuester & Stefan Mittnik & Marc S. Paolella, 2006. "Value-at-Risk Prediction: A Comparison of Alternative Strategies," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(1), pages 53-89.
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