Abstract
Managers, sponsors, and consultants all have an interest in understanding the capacity of investment products. Capacity is the maximum asset level at which a product can deliver the expected performance (on average) over time. A framework for analyzing capacity should be useful for understanding its driving forces. Under transaction cost-aware portfolio management, expected alpha net of costs turns out to decay very slowly with increasing asset levels; large errors in estimated capacity lead to only small errors in expected alpha net of costs. Building portfolios without regard to costs, however, leads to substantially lower capacity. Negative returns do not necessarily signify capacity problems, but increasing costs usually signify suboptimal portfolio management. Asset growth should be managed and size regularly compared with available capacity. Managers can increase capacity by improving their intrinsic information ratio and by reducing transaction costs, perhaps through better approaches to trading.
- © 2005 Pageant Media Ltd
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