Seeking alpha
Back in 1969, Jensen has studied the performance of 115 funds for 10 years. He calculated the difference between the return of the funds minus the expected return of the fund, according to the CAPM model. Jensen has computed what is known as the alpha of the funds:
From that research, this “alpha” has been given the name the Jensen Index. The research showed that 50.4% of the funds that have achieved a positive alpha, had achieved in the following year a positive alpha.
The picture above shows the percentage of funds that have achieved lower returns than the Wilshire 500 index.
Another research by Frank Russel Co. showed that out of a sample of 100 private fund managers, those who have achieved better returns than other funds for a certain period (83-86), were not able to do so in the following period (87-90).
The above research shows the inconsistencies in returns by funds which go along with the notion of an efficient market.
Is it worthwhile to invest in stocks?
There is a problem here. If fund managers can’t translate stock analysis to outperform the market, then they won’t invest in the first hand in analyzing the stocks. If all managers do so, the prices of stocks will not reflect their fair price and it will be again worth while to analyze the stocks! This means there is an equilibrium point where a handful of fund managers do invest the time to analyze earning reports and are compensated with returns.
The conclusion for the small investor
Big funds have lower costs of fundamental analysis than the small investor. Hence he will be better off buying a passive investment such as the market index.
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