The evaluation of active manager returns in a non-symmetrical environment
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Ron Bird studied at Monash University prior to taking up a lectureship at Macquarie University in 1970. He moved to the Australian National University in 1973 and was subsequently promoted to Professor and Head of the Commerce Department. After leaving in 1988, the Australian National University awarded him the title of Emeritus Professor. Initially, in his private sector career, he headed up Towers Perrin’s asset consulting operations in the Asian region while also being in charge of their global research. He moved to funds management in 1992, first being in charge of research and product development at Westpac Investment Management prior to founding GMO Australia in 1995. He returned to academia in 1999 and took up his current position in the School of Finance and Economics at the University of Technology, Sydney.
David R Gallagher* is a doctoral candidate in the School of Business at the University of Sydney, Australia. *Securities Industry Research Centre of Asia-Pacific (SIRCA), PO Box H58, Australia Square, Sydney, NSW 1215, Australia. Tel: ⫹61 (2) 8296 7841; Fax: ⫹61 (2) 9299 1830; e-mail: [email protected]
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. Keywords: investment performance; moments of distributions; normality; performance rankings
䉷 Henry Stewart Publications 1470-8272 (2002)
Vol. 2, 4, 303-324
Journal of Asset Management
303
Bird and Gallagher
Introduction The most critical foundation of modern portfolio theory (MPT) centres on the relation
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