Abstract
Previous research demonstrated how current measures of risk–adjusted performance are insufficient for ranking investment managers or structuring portfolios, and provided an alternative measure called correlation–adjusted performance (CAP). The new measure accounts for differences in standard deviations, the correlation between portfolios and the benchmark, and the fact that investors have a target relative risk. In this article, the author extends the analysis for institutional investors with multiple manager portfolios. This technique facilitates optimal portfolio construction by combining the risk–free asset, the benchmark, and many investment managers. Since managers are less than perfectly correlated with each other, unattractive managers on a stand–alone basis may be chosen for their diversification properties and overall risk–adjusted performance can be increased over that of the highest yielding manager. The author also shows that the case for passive management is greatly diminished under this paradigm.
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