A “Probability of Skill” Frontier for Allocating Between Active and Passive Strategies
Agenda
Presented by Northfield President Dan diBartolomeo.
Whenever an investor chooses to invest in an actively managed strategy, they are implicitly stating belief in two propositions. The first is that the active manager is going to produce risk-adjusted excess returns (above benchmark return + fees). The second is that investors can determine in advance which managers will outperform in the future. To the extent that it is arithmetically impossible for all active managers to outperform the average, investors can express a level of likelihood (i.e. 80/20, 50/50) that these two beliefs are true.
In this presentation, we will illustrate a compact formulation of the problem that allows investors to choose between an active manager and a passive portfolio conditional on the expected probability of correctness of the two propositions.
Three alternative framings of the problem will be provided based on diBartolomeo (JPM, 2023) and diBartolomeo and Khorami (Working paper 2026). The risk adjustment term is derived from Litzenberger and Rubinstein (JoF, 1976).
About Dan diBartolomeo
Dan diBartolomeo is President and founder of Northfield Information Services, Inc. He is also a former Visiting Professor at the CARISMA Research Center of Brunel University in London and serves on the Board of Directors of the Chicago Quantitative Alliance and the advisory board of the International Association for Quantitative Finance. He is a regional director of the Professional Risk Managers International Association, (PRMIA), and the Quantitative Work Alliance for Applied Finance, Education and Wisdom (QWAFAFEW). He is past president and director of the Boston Economic Club.
Dan has been admitted as an expert witness in US federal courtsand state courts for litigation matters regarding investment managementpractices and derivatives.
In 2010, Dan received an award from Institutional Investor magazine as one of the forty most influential executives in financial technology in connection with his analytical work that helped uncover the Madoff investment fraud.
Dan is a director of the American Computer Foundation, and formerly served on the industry liaison committee of the Department of Statistics and Actuarial Sciences at New Jersey Institute of Technology. He continues his more than twenty years of service as a judge in the Moskowitz Prize competition, given by the University of California at Berkeley for excellence in academic research on socially responsible investing.
Dan has a long list of publications including books, book chapters and research papers in professional journals such as Financial Analyst Journal, Quantitative Finance and Journal of Investing. In 2017, he was named co-editor of the Journal of Asset Management.