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The evaluation of active manager returns in a non-symmetrical environment

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Abstract

This paper examines the moments of the active return distributions of investment managers. While modern portfolio theory assumes asset return distributions are Gaussian normal, the empirical evidence overwhelmingly documents asset returns to be leptokurtic and fat tailed. In addition, the evaluation of investment manager performance has relied almost exclusively on the Capital Asset Pricing Model (CAPM), which assumes investors are only concerned with the interaction between the first and second moments of a return distribution — mean and variance. Little empirical work exists, however, evaluating the implications for performance measurement methods of taking into account the higher moments of active return distributions — namely skewness and kurtosis. This paper takes up this issue with respect to the performance of funds invested in domestic equities, domestic fixed interest and international equities sectors on behalf of investors in Australia, Canada, Japan, the UK and the US. First, the paper documents active fund returns distributions to be inconsistent with a Gaussian normal distribution, confirming previous studies examining asset returns. Secondly, the paper demonstrates the usefulness of the higher moments of fund active return distributions in evaluating portfolio performance and risk. Thirdly, the paper further extends the performance measures to take account of the investors' differential preference between added value in rising and falling markets. It concludes that more work needs to be done in all of these areas, but this paper provides a very useful step along the way.

Suggested Citation

  • Ron Bird & David Gallagher, 2002. "The evaluation of active manager returns in a non-symmetrical environment," Published Paper Series 2002-2, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  • Handle: RePEc:uts:ppaper:2002-2
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    File URL: https://link.springer.com/article/10.1057/palgrave.jam.2240055
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    Cited by:

    1. Kingsley Fong & David R. Gallagher & Aaron Ng, 2005. "The Use of Derivatives by Investment Managers and Implications for Portfolio Performance and Risk," International Review of Finance, International Review of Finance Ltd., vol. 5(1‐2), pages 1-29, March.
    2. Claudio Giannotti & Gianluca Mattarocci, 2013. "The Role of Risk Measures Choices in Ranking Real Estate Funds: Evidence from the Italian Market," Palgrave Macmillan Studies in Banking and Financial Institutions, in: Alessandro Carretta & Gianluca Mattarocci (ed.), Asset Pricing, Real Estate and Public Finance over the Crisis, chapter 10, pages 165-189, Palgrave Macmillan.
    3. Alessandro Carretta & Gianluca Mattarocci, 2009. "Funds of Funds Portfolio Composition and its Impact on Performance: Evidence from the Italian Market," Palgrave Macmillan Studies in Banking and Financial Institutions, in: Alessandro Carretta & Franco Fiordelisi & Gianluca Mattarocci (ed.), New Drivers of Performance in a Changing Financial World, chapter 5, pages 69-88, Palgrave Macmillan.
    4. Zeno Adams & Roland Füss & Volker Wohlschieß, 2012. "Investment choice and performance potential in the mutual fund industry," Journal of Asset Management, Palgrave Macmillan, vol. 13(2), pages 84-101, April.
    5. Doan, Phuong & Lin, Chien-Ting & Zurbruegg, Ralf, 2010. "Pricing assets with higher moments: Evidence from the Australian and us stock markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(1), pages 51-67, February.
    6. Simone Brands & David R. Gallagher, 2005. "Portfolio selection, diversification and fund‐of‐funds: a note," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 45(2), pages 185-197, July.

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