Expected alpha from active fund managers can be forecasted—as long as one is mindful of the rules of the zero-sum game of investing. Explicit forecasts are preferred over implicit forecasts because sponsors can use explicit forecasts to build optimized portfolios of managers with improved manager weighting. To make explicit alpha forecasts, the investor combines two equations derived from the fundamental law of active management. The elemental variables for the equations are the sponsor’s estimate of the manager’s “goodness” at beating the manager’s benchmark, the sponsor’s assessment of the sponsor’s skill in estimating manager ability, the cross-sectional standard deviation of manager skill, portfolio breadth, implementation efficiency, expected active risk of the portfolio, and fees.

Author Information

M. Barton Waring is a managing director and chief investment officer for investment policy and strategy, emeritus, for Barclays Global Investors, San Francisco.

Sunder R. Ramkumar is a strategist with the Client Advisory Group at Barclays Global Investors, San Francisco.

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