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The Journal of Alternative Investments

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Article

What Is the True Cost of Active Management? A Comparison
of Hedge Funds and Mutual Funds

Jussi Keppo and Antti Petajisto
The Journal of Alternative Investments Fall 2014, 17 (2) 9-24; DOI: https://doi.org/10.3905/jai.2014.17.2.009
Jussi Keppo
is an associate professor at the NUS Business School and Risk Management Institute at National University of Singapore in Singapore.
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  • For correspondence: keppo@nus.edu.sg
Antti Petajisto
is a portfolio manager at BlackRock in San Francisco, CA.
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  • For correspondence: antti.petajisto@sloan.mit.edu
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Abstract

On the surface, hedge funds seem to have much higher fees than actively managed mutual funds. However, the true cost of active management should be measured relative to the size of the active positions taken by a fund manager. A mutual fund combines active positions with a passive position in the benchmark index, which can make the active positions expensive. A hedge fund takes both long and short positions and uses leverage, which makes the active positions cheaper, but this can be offset by the expected incentive fees, especially for more volatile funds. In this article, the authors investigate the trade-offs from the perspective of a fund investor choosing between a mutual fund and a hedge fund, examining the impact of leverage, volatility, Active Share, nominal fees, and alpha for a realistic range of parameter estimates. Their calibration shows that a moderately skilled active manager is approximately equally attractive to investors as a mutual fund manager or a hedge fund manager is, showing that both investment vehicles can coexist as efficient alternatives to investors. Further, their model explains documented empirical findings on career development of successful fund managers and on risk- taking in hedge funds.

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The Journal of Alternative Investments: 17 (2)
The Journal of Alternative Investments
Vol. 17, Issue 2
Fall 2014
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What Is the True Cost of Active Management? A Comparison
of Hedge Funds and Mutual Funds
Jussi Keppo, Antti Petajisto
The Journal of Alternative Investments Sep 2014, 17 (2) 9-24; DOI: 10.3905/jai.2014.17.2.009

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What Is the True Cost of Active Management? A Comparison
of Hedge Funds and Mutual Funds
Jussi Keppo, Antti Petajisto
The Journal of Alternative Investments Sep 2014, 17 (2) 9-24; DOI: 10.3905/jai.2014.17.2.009
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