Given developments in academic research, technology, and access to product strategies, more investors are assessing whether traditional active managers are generating excess returns that cannot be explained by well-known style factors, which can now be purchased directly and cheaply by investors worldwide. Some may be content with what they find. Others, however, may be surprised to learn that what they have been getting from a manager is just a fairly consistent tilt toward one or more of these factors, when their objective for hiring the manager may have been solely to generate positive alpha.
In cases where traditional active managers are not adding unique value or are charging too much, replacing them with factor strategies may provide the end investor with a way to generate excess return with greater transparency, more risk control, and lower implementation costs.
We develop an accessible method to test to what extent the returns of a traditional active manager can be replicated using factor-based strategies. This framework has a number of practical applications, including replacing a manager who is not delivering net alpha above investable factor exposure and performing due diligence on prospective managers.
Read more...
(Click on the cover page image for the full document).