Among the seven methodologies, five had positive average alphas (Dow Jones, Dow Jones Wilshire, Morningstar, S&P and S&P Pure), and S&P’s Pure methodology had the highest alpha, at 1.16 percent, although only Morningstar had an average alpha that was statistically significant (with an average alpha of 0.74 percent and a t statistic of 2.05). On a weighted basis, five methodologies had positive alphas: Dow Jones Wilshire, Morningstar, S&P, S&P Pure and Russell, with Morningstar having the highest weighted alpha, of 1.12 percent, which could largely be attributed to the alpha of its large blend index (1.32 percent).
The range of outperformance decreases on a risk-adjusted basis (Figure 3) when compared with the raw outperformance (Figure 2), to 3.57 percent from 4.28 percent, respectively. There were also some changes in relative outperformance when viewed on a risk-adjusted basis. For example, over the 12-year test period the Dow Jones Wilshire Small Growth Index outperformed the Dow Jones Small Growth Index by 0.09 percent (on an annualized basis, 2.75 percent and 2.66 percent, respectively); however, on a risk-adjusted basis, the Dow Jones Small Growth Index outperformed the Dow Jones Wilshire Small Growth Index by .89 percent (on an annualized basis, 0.02 percent and -0.87 percent, respectively).
The respective alpha estimates for the various indexes were quite consistent during the test period, both on a relative and absolute basis. Figure 4 provides an example; it includes the rolling three-year four-factor regression alphas for the large blend indexes included in the analysis.
As shown in the graph, while the absolute numbers fluctuate over time, the relative rankings change very little during the test period. In the aggregate, when viewed at the ranked index level, Dow Jones, Dow Jones Wilshire, Morningstar, S&P and S&P Pure tended to have relatively consistent rankings that were slightly above average, while MSCI and Russell had rankings that tended to be significantly below average (they also were the two methodologies with negative average alphas). The persistence in alpha should not be that surprising, given the fact the factor estimates for the indexes were relatively constant over time (they are indexes, after all). Combined, these findings suggest that it is likely that some methodologies are likely to persistently generate positive/negative alphas relative to their peers in the future.