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06/11/91

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Nobel laureate on investment portfolio 'fishing'

STANFORD -- To predict the performance of an investment portfolio, Nobel Prize-winning economist William F. Sharpe said, it is more important to examine in which lake it is fishing than who is choosing the lures.

Sharpe, noted for his fundamental work on the economics of portfolio analysis and finance, examined methods for evaluating the performance and strategies of investment portfolio managers in a mid-May address to associates of Stanford University's Center for Economic Policy Research.

Using a fishing analogy, Sharpe compared the investment "style" to the choice of lake in which to fish and "selection" to the skill in catching fish of above-average size from the chosen lake.

Investors differ in the length of time over which they expect to realize returns from their investments and in the volatility in the value of their portfolios that they are willing to accept, he said. Choosing portfolio managers, therefore, involves assessing the managers' styles. A portfolio manager's style is especially critical since some 80 to 90 percent of the variation in returns is accounted for by this factor, Sharpe said.

Differences at picking stocks, therefore, only account for 10 to 20 percent of the variation in returns attributable to choosing a portfolio manager.

This means, Sharpe said, that the choice of class of assets in which to invest is the largest determinant of investment return, and that the choice of a portfolio manager within this class has only a modest impact.

Sharpe illustrated the point by reviewing the performance of 408 mutual funds over an extended period of time. Historically, it was difficult to predict future selection ability based on past performance. It was, however, possible to distinguish styles of mutual funds, and these styles were generally stable over time.

Sharpe's talk concluded the Stanford center's annual Associates Discussion Series for the 1990-1991 year. Other speakers in the series included John Boatwright, chief economist of Exxon USA; Jack Beebe, senior vice president and director of research, Federal Reserve Bank of San Francisco; A. Michael Spence, dean of the Graduate School of Business; John Taylor, President's Council of Economic Advisers, on leave from Stanford's Department of Economics; Roger Noll, professor of economics and director, CEPR's Program in Regulatory Policy; and Bowen McCoy, president, Buzz McCoy Associates.

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