What it Takes to Beat a Benchmark

Abstract

The relationship between a manager's level of skill and the actual value-added to a portfolio can be nebulous. Actual portfolio results are often only minimally correlated with the manager's skill level. A framework for quantifying the expected value-added of a constrained portfolio focuses on the three distinct factors that contribute to investment performance: a manager's forecasting skill ability to predict excess returns; the manager's range of opportunities to apply skill across securities and over time; the flexibility provided for a manager to express forecasting skill in a portfolio that is constrained to some degree.