Examining “Real Alpha” and “Exotic Beta” in mutual funds

Feb 1st, 2010 | Filed under: Academic Research, CAPM / Alpha Theory, Retail Investing, Today's Post | By:
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nicheWith the explosion of hunters searching for the same scarce alpha and the proliferation of high-frequency trading, is asset management still all about alpha?  Yes, says Jane Li, CAIA, of  FundQuest, a division of BNP Paribas.  Her research of over 10,000 mutual funds (both alive and dead) collectively managing $4  trillion shows that it depends on which category of fund you’re talking about. More…

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  1. Reading ‘Examining “Real Alpha” and “Exotic Beta” in mutual funds’ on allaboutalpha.com and the subsequent FundQuest white paper ‘What Now – Active or Passive Management? Examining Real Alpha and Exotic Beta’ two questions arise:

    1. What about risk?
    Active management entails taking on more risk, simply by taking a smaller and active sample from a broad based index. Why are the returns in the study not corrected for this risk?

    2. What is the return distribution difference of active vs. passive management?
    Because (portfolio / fund) risk changes going from passive to active management, is it save to assume that the risk profile also changes? This would be a welcome addition to the research.

    Thank you for your attention.

    Kind Regards,

    Michael W.A. Kaal, CAIA
    Directeur AFS Capital Management

  2. To answer to the question “What about risk?” and the perception that active management adds to risk.

    Active trading does not necessarily involve incremental risk. I some cases, it does in fact involve avoiding risks, such as:

    – reducing positions as trends become over-extended, and as “gap risk” is increasing incrementally
    – monetizing gains (in part or whole) and moving on to the next idea
    – reducing overnight exposures, and thus greatly reducing gap risk (when it exist the most)
    – reducing broad (gross) portfolio exposures as market volatility is increased

    These are examples or “active” risk-reducing actions that are applicable in both traditional and absolute return environments.

    The implementation of passive and static positions and waiting for the market to realize that you are right does in fact increase risk, no matter how compelling they are.

    Rene Levesque

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