Don’t look too closely: You will find some of the decision-making that goes into an index is discretionary. Yep, there is a committee in the background picking stocks! Both the S&P 500 and the Dow 30 have an index selection committee that picks the firms that best represents the goals of the index. Not really objective.If your task is to evaluate any kind of active manager’s performance, you are trying to determine if he or she has skill or luck. The best way to do that, in my opinion, is to compare the actual manager to a random version of him or herself. If the manager significantly out-performs our random portfolios we know they add value, regardless of how they do relative to the Using the random portfolio generator discussed below, you can create thousands of random portfolios. You can represent pretty much any equity strategy (long only, short only, bear bias, long bias, market neutral, etc.) and any fund-of-fund portfolio construction technique
Lonely Path
A gray cat slinks past a wooden house. There’s something a little intimidating attempting to describe
If your task is to evaluate any kind of active manager’s performance, you are trying to determine if he or she has skill or luck. The best way to do that, in my opinion, is to compare the actual manager to a random version of him or herself.
If your task is to evaluate any kind of active manager’s performance, you are trying to determine if he or she has skill or luck. The best way to do that, in my opinion, is to compare the actual manager to a random version of him or herself.
What Else Can You Use?
In my case, I put together portfolios of hedge funds and managed futures strategies. I can use the same process to evaluate my own approach to selecting managers: I compare the portfolios I create following my portfolio construction methodology with random portfolios drawn from the same universe. By choosing which aspects of the portfolio construction process are controlled or random, I can explore the impact of each aspect on the final portfolios I create instead of using the manager’s skill or process, we build thousands of portfolios each month within the stated constraints and see how they perform versus our manager.
- Create a fixed number of portfolios with a fixed number of assets in each net exposure randomly subject to a maximum and minimum.
- Allow both long and short positions which combine to deliver a fixed net randomly subject to a maximum and minimum.
- Control the maximum and minimum total short exposure in the portfolio
- Provide optional reporting on the population of portfolios generated
- What net exposure and the total number of positions do I want?
- How much of that am I prepared to carry on the short side? Randomly subject to a maximum and minimum.