Calculating alpha as the market crashes
Feb 18th, 2009 | Filed under: Performance, Analytics & Metrics, Today's Post
Investment consultant Hewitt Associates said last week that the majority of active long-only managers underperformed their passive benchmarks last year. This is particularly poor given that the cash holdings and inherent business caution of many mutual fund managers generally results in a lower volatility than the market (along with commensurately lower losses in bad years and lower gains in good years).
Hewitt blamed the usual culprits: management fees and trading costs. But the firm also pointed to an active bet that went sour for many of the world’s managers: an overweight position in financial right before the debacle known as Q4.
The result, says the firm, is that “some pension funds are already considering switching to passive management, as a way of generating growth through cutting costs.”
“Market Adjusted Alpha”
But the performance of some managers may have been even worse if you use a performance metric proposed by Al Ehrbar in this P&I article. Ehrbar is credited with popularizing Economic Value Added (EVA). So it may be prudent to check out what he has to say about measuring “alpha” in down markets. (We put alpha in quotes since he uses a simplified version of our favorite Greek letter – one that may be more commonly used in practice than, say, Jensen’s Alpha.) More…
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