Abstract:
Actively-managed funds have recently come under fire as it has been determined that
they consistently underperform passive funds. Benchmarking, and the constraints
placed on actively-managed funds, are standard practices within the industry, but
research suggests that these constraints negatively affect fund performance.
This research paper explores the effectiveness of actively-managed funds in relation to
their benchmark indices, in terms of tracking errors and weighting constraints. This is
done by qualifying the effect of these constraints on the performance of hypothetically
constructed portfolios in relation to the FTSE / JSE Top 40 Index. The results are
presented graphically and show that tracking error limits did, as expected, limit the
possible upside returns of these funds. It was found however, that the tracking error
constraints had a much greater effect on limiting downside risk than they had on
limiting upside effects. Weighting limitations did not have a single universal effect on
the simulated portfolios’ performance but affect performance in conjunction with
tracking error limits.
It was concluded that for the hypothetically constructed portfolios for the period studied,
constraints did not affect the possible upside return to such a magnitude that the
constraints themselves could account for the underperformance of actively managed
funds and they had an overall positive effect on performance.
