DP7676 Performance Maximization of Actively Managed Funds

Author(s): Paolo Guasoni, Gur Huberman, Zhenyu Wang
Publication Date: February 2010
Keyword(s): alpha, hedge funds, mutual funds, options, portfolio management
JEL(s): G11, G12, G13, G14
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7676

Ratios that indicate the statistical significance of a fund?s alpha typically appraise its performance. A growing literature suggests that even in the absence of any ability to predict returns, holding options positions on the benchmark assets or trading frequently can significantly enhance performance ratios. This paper derives the performance maximizing strategy - a variant of buy-write - and the least upper bound on such performance enhancement, thereby showing that if common equity indexes are used as benchmarks, the potential performance enhancement from trading frequently is usually negligible. The enhancement from holding options can be substantial if the implied volatilities of the options are higher than the volatilities of the benchmark returns.