Measuring the Effects of Foresight and Commitment on Portfolio Performance

39 Pages Posted: 23 Mar 2009 Last revised: 19 Aug 2009

See all articles by Kenneth Khang

Kenneth Khang

Idaho State University

Thomas W. Miller, Jr.

Mississippi State University; Consumers' Research

Date Written: August 18, 2009

Abstract

A central question in finance is how to measure portfolio performance. We assert that foresight (i.e., the ability of managers to forecast relative returns) and commitment (i.e., the aggressiveness with which managers act on their foresight) are necessary ingredients to generate portfolio performance not attributable to chance. We create two portfolio performance measures free from the need to pre-specify a benchmark portfolio. Our measures allow for many investment styles because they use benchmarks created from the style implied in the portfolio being tested. To calibrate these new measures, we use a weight-generating process that simulates various combinations of foresight and commitment. We decompose our measures to show how foresight and commitment act jointly to generate statistically measurable excess performance. An outcome of our measures is a scoring mechanism that groups portfolios by commitment, and then ranks portfolio performance by foresight. We apply our measures to a series of actual asset allocation recommendations made by a panel of Investment Houses. Largely, we find little foresight, but we document considerable aggression. The Investment Houses made allocation recommendations to equity, bonds, and cash. However, our measures easily generalize to a wide variety of potentially hard to measure investment styles, like those of hedge funds and other alternative investment managers.

Suggested Citation

Khang, Kenneth and Miller, Jr., Thomas W., Measuring the Effects of Foresight and Commitment on Portfolio Performance (August 18, 2009). Available at SSRN: https://ssrn.com/abstract=1364197 or http://dx.doi.org/10.2139/ssrn.1364197

Kenneth Khang (Contact Author)

Idaho State University ( email )

921 South 8th Avenue
Pocatello, ID 83209
United States

Thomas W. Miller, Jr.

Mississippi State University ( email )

Mississippi State, MS 39762
United States

Consumers' Research ( email )

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