Friday, November 28, 2008

Where does alpha come from?

Alpha comes from maximising winners and minimising losers, according to research carried out by Inalytics (reported in

“The typical manager, however, compensates for a mediocre hit rate by generating good gains from the winners,” according to the report. The win/loss ratio — defined as the alpha generated from good decisions compared to the alpha lost from wrong decisions — averages 102%. This translates to an average alpha of two percentage points.

Active equity managers also obtain more alpha in their overweight decisions than their underweight choices. Managers made the correct decisions to overweight a stock relative to its appropriate index about 48.5% of the time. But the win/loss ratio was 113.9%, meaning alpha averaged 13.9 percentage points.

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