There are two basic approaches to the portfolio management - passive and active.
The optimal allocation of the above mentioned components of the passive management approach requires a reliable estimate of the variance and expected return that are possible to measure with some analysis. Moreover, according to the Efficient Market Hypothesis (EMH) all the assets on the market should be efficiently priced that implies that the described passive management strategy should work.
However, there is some evidence that active managers may have a superior performance relative to the managers that utilize passive strategy. One of the objectives of the active portfolio managers is to construct a risky portfolio that maximizes the Sharpe's measure that means maximizing the slope of Capital Allocation Line (CAL). Thus a "good" active manager has a steeper CAL or reward-to-variability ratio than that of a passive manager. This relation points out one of the ways to evaluate the performance of active versus passive strategy managers through the use of a realized Sharpe's ratio as one of the ways to assess relative risk-adjusted return. Ideally, clients will pick the manager with a higher Sharpe's ratio that probably has the real ability to forecast returns. The constant stability over time in performance of such a manager will help to define the optimal fracture of the portfolio to be invested with the manger to get a desired return within the specified variance level.
The choice of an optimal measure to asses the performance of an actively managed portfolio depends on the role of the observed portfolio. For example, Sharpe's ratio is used when the portfolio represents the entire investment fund, Treynor measure - when the scrutinized portfolio represents one sub-portfolio of many, and the Information ratio can be applied to measure the return, when the portfolio under question is composed of both actively and passively managed portfolios.
The perfect market timing is able to add value to the performance of active mangers; however, the rate of return for such manager will be uncertain. Moreover, this means that standard portfolio risk measures are unable to catch the real risk characteristics thus providing also an opportunity for a downside scenario.
With this being distressing, the studies of mutual fund performance did not reveal any considerable ability to outperform the market index; however it is believed that good active managers can save the losses during the market downswings thus adding overall value to the portfolio.
To evaluate active portfolio management from the client's perspective, it is important to remember that is has its price. In other words, potential customer should weight expected value-added from the active portfolio management versus additional expenses and make a decision based on the adjusted price.