Sharath Sury, Manda B. Sury - Analytic Due Diligence with an Alpha Cost Index
Sury,
Sharath M. and
Sury, Manda B, Analytic Due Diligence Using an Alpha Cost Index (April 16, 2006). Available at SSRN: http://ssrn.com/abstract=1482904
Analytic Due Diligence Using an Alpha Cost Index
Posted October 6, 2009 on papers.SSRN.com
Abstract:
Effective portfolio managers recognize that not all returns are created equally. Investment strategies can deliver returns that are the result of systematic (market or beta) exposures, nonsystematic (skill or alpha) exposures, and random variation. The relative proportions of alpha, beta, and randomness vary across strategies and even within strategies as they evolve over time. Historically, most investment products have bundled alpha and beta. However, as low-cost, investable proxies for beta grow more pervasive, it is increasingly important for portfolio managers to consider only those actively managed products that are truly delivering incremental alpha. In this article, we introduce a new measure that adjusts product fees to account for the level of alpha delivered—the Alpha Cost Index (ACI). The ACI levels the playing field by penalizing products that charge active management fees but deliver the preponderance of their returns from beta exposures; thus serving as a useful ranking tool for due diligence.
Keywords: hedge funds, alpha, beta, fees, due diligence
JEL Classifications: G10, G19
Working Paper Series