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Constructing and Using Double-adjusted Alphas to Analyze Mutual Fund Performance

Author

Listed:
  • Erik Kole

    (Erasmus Universiteit Rotterdam)

  • Reza Brink

    (Erasmus Universiteit Rotterdam)

Abstract

We propose a new approach for estimating mutual fund performance controlling for both factor exposure and characteristics. Motivated factor models’ failure to fully adjust returns for anomalies, our hierarchical Bayesian model separates the true alpha from the effect of stock characteristics. It is straightforward and improves the traditional two-pass estimation. Our double-adjusted alphas produce a different ranking of mutual funds than the traditional alphas. Consequently, evidence of persistence in performance increases, the link between selectivity and alpha disappears, but fund flows are related to the true alpha and not to characteristics. Concludingly, measuring true outperformance is crucial for understanding skill.

Suggested Citation

  • Erik Kole & Reza Brink, "undated". "Constructing and Using Double-adjusted Alphas to Analyze Mutual Fund Performance," Tinbergen Institute Discussion Papers 19-029/IV, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20190029
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    More about this item

    Keywords

    Mutual fund performance; Double-adjusted performance; Firm characteristics; Hierarchical Bayes;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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