The John Cook School of Business will host the first of its Fall 2011 Seminar Series from 12:30 p.m. to 1:30 p.m. Sept. 16 in room L-27 at the John Cook School of Business Atrium.
Brian Betker, Ph. D., will present "A comparison of single factor and multiple factor alphas used in measuring mutual fund performance."
Synopsis of the paper
Conversations between this paper's authors about measuring mutual fund performance led them to realize that the practitioner and the academic were looking at alpha in potentially rather different ways. The standard practitioner-oriented databases report single-factor alphas (S&P 500, best fit or style allocation), whereas standard academic practice to is to use the three- or four-factor models of Fama and French (1993) and Carhart (1997) to estimate alpha. It seemed logical to ask whether this made any difference when evaluating funds. We look at absolute performance as well as relative performance (quartile rankings).
We find that single-factor alphas are larger than multi-factor alphas by 50 to 75 basis points on average. This result is concentrated in small cap funds; large cap fund alphas are not meaningfully different using best-fit or style allocation alphas compared to three- or four-factor alphas. However, for small cap funds the single-factor methods produce alphas that are more than 200 basis points larger than the multi-factor methods. Single factors alphas are also more likely to show persistence than multi-factor alphas. When it comes to relative performance, funds that are ranked as top-quartile by the single-factor methods are not ranked as top-quartile 20 to 25 percent of the time when using multi-factor methods.