Tags: active management | benchmarking | Due Diligence

Half of the active managers should beat their benchmark, yet evidence suggests they do not. That is, evidence contradicts Dr. William F. Sharpe’s acclaimed “Arithmetic of Active Management,” which predicts that managers collectively will earn the benchmark return, with half exceeding it and half trailing it. Clients want performance but they are not even getting a 50-50 shot at it, due in large part to the inability of many advisors to identify skill. That’s because many of you are measuring performance with a ruler – the wrong instrument.

The three key due diligence questions are:
What does this manager do?
Does he do it well?
Why?

The third question is attribution, and is the most forward-looking. To get an accurate answer you need a holdings-based system that provides an accurate benchmark, because if the benchmark is wrong all of the analytics are wrong. There are only a few attribution systems that allow custom benchmarks, such as FactSet and StokTrib. Most attribution systems are limited to off-the-shelf indexes as benchmarks, which only work for index huggers.

So these are some of the better methods. More details are available at www.ppca-inc.com and www.stoktrib.com. These contemporary improvements have not become mainstream because some, albeit a minority, benefit from the status quo – theyprefer to see due diligence remain in the Dark Ages. Are you happy with the status quo? If not, what are you waiting for?