Luck vs. Skills: the Fama and French paper (Part II)

As I anticipated in the previous blog, I ran the Fama and French analysis on the 5 top performer mutual funds.

First, I checked their yearly returns. The funds are anonymized, but you can see that "fund 2" has the best yearly return from 2010 (ca 45%). The other funds are not doing badly either, with a yearly return between 30 and 40%.

Now, we want to see whether their good performances are just due to luck or whether we can rely on the good skills of the fund manager for the future. We calculated their t_alphas as described in the Fama and French paper.

 t_alpha indicates the amount of skill (the higher, the better). p90 and p95 mark the thresholds for 10% and 5% luck component in performance.
 
Funds 1, 4, and 5 are probably run by skilled managers because their t_alpha lies beyond their p90 value.
Fund 2 shows a remarkably high yearly return (45%), but its is likely due to luck because of its small t_alpha (0.28).
Fund 3’s return is only slightly higher than Fund 1’s, but its t_alpha indicates that its performance could well be due to luck.

In conclusion, fund 2, that was showing the best yearly return, has actually the highest luck component.

If you are interested in getting your funds tested in terms of their skill/luck mixture, just contact us for more information.