The evaluation of active manager returns in a non-symmetrical environment

This paper examines the moments of the active return distributions of investment managers. While modern portfolio theory assumes asset return distributions are Gaussian normal, the empirical evidence overwhelmingly documents asset returns to be leptokurtic and fat tailed. In addition, the evaluation of investment manager performance has relied almost exclusively on the Capital Asset Pricing Model (CAPM), which assumes investors are only concerned with the interaction between the first and second moments of a return distribution — mean and variance. Little empirical work exists, however, evaluating the implications for performance measurement methods of taking into account the higher moments of active return distributions — namely skewness and kurtosis. This paper takes up this issue with respect to the performance of funds invested in domestic equities, domestic fixed interest and international equities sectors on behalf of investors in Australia, Canada, Japan, the UK and the US. First, the paper documents active fund returns distributions to be inconsistent with a Gaussian normal distribution, confirming previous studies examining asset returns. Secondly, the paper demonstrates the usefulness of the higher moments of fund active return distributions in evaluating portfolio performance and risk. Thirdly, the paper further extends the performance measures to take account of the investors' differential preference between added value in rising and falling markets. It concludes that more work needs to be done in all of these areas, but this paper provides a very useful step along the way.