Which quantitative metrics are most important in manager due diligence?

Question

AcadiFi · Accepted Answer

Risk-adjusted and attribution-based metrics matter more than raw returns. Key ones:

1. Information Ratio (IR) = (R_p - R_b) / TE. Measures alpha per unit of active risk. Good managers sustain IR > 0.5; top quartile > 0.75.

2. Sharpe Ratio = (R_p - R_f) / sigma_p. Absolute risk-adjusted return; useful across asset classes.

3. Up/Down Capture Ratios. Up capture > 100% and down capture < 100% indicates good defensive characteristics. Batting average = % of periods outperforming benchmark.

4. Tracking Error (TE). Volatility of active returns; indicates how aggressive the active bets are. High TE managers need high IR to justify.

5. Alpha persistence — rolling 3-yr or 5-yr IR stability. Consistent modest IR > erratic high IR.

6. Factor attribution (Fama-French, Carhart): how much of return is explained by known factors vs unexplained 'true' alpha? A manager whose 'alpha' disappears after adjusting for size/value/momentum/quality is not genuinely skilled.

Example: Rivergate Asset Management over 10 years: R_p=9.8%, R_b=8.2%, TE=4.2%. IR = (9.8-8.2)/4.2 = 0.38 — mediocre. Up capture 108%, down capture 92% — decent defensive. But factor attribution shows 1.4% of the 1.6% excess comes from systematic small-cap tilt, so true alpha = 0.2%. Not worth fees.

```mermaid
flowchart LR
  A[Raw Returns] --> B[Sharpe/IR]
  B --> C[Capture Ratios]
  C --> D[Factor Attribution]
  D --> E[True Alpha]
```

Key insight: multi-factor attribution often reveals that 'alpha' is actually exposure to rewarded risk premia, available cheaper via smart-beta.

Which quantitative metrics are most important in manager due diligence?

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