Fund management , fund performance , measurement stock picking
Abstract:
This paper takes a closer look at utility based performance measurement proposed by Goetzmann et al. (2007) and used in popular Morningstar star ratings. Utility based per- formance measures offer a very intuitive way of risk correction and are hard to manipulate. They require, however, a proper benchmark measure to filter out lucky funds. I propose to use the Daniel et al. (1997) (DGTW) characteristic based benchmark portfolios as bench- marks for the utility based performance measure. I find that the DGTW selection measure consistently overestimates the manager’s selection skills in certainty equivalent terms, and that this overestimation can be decomposed into an idiosyncratic and a systematic compo- nent. In diversified fund portfolios, the certainty equivalent selection measure is, on average, 87bps higher than in undiversified fund portfolios. The remaining undiversifiable risks cost 47bps per year in certainty equivalent terms and can be explained in part be imprecise correction for known systematic risk factors, in part by unknown but undiversifiable risk factors. The certainty equivalent measure captures risk particularly well in years with high moment realizations of the CRSP value weighted index.
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