Swedroe: True Alpha A Rare Thing

June 20, 2018

 

Dimensional’s structured portfolios outperformed their comparable iShares ETFs by an average of 0.2 percentage points.

Out-Of-Sample Performance

One of the reasons for the well-documented lack of persistent outperformance is that successful active management sows the seeds of its own destruction as cash inflows increase the hurdles to generating alpha. With that in mind, using the regression tool available at Portfolio Visualizer, I’ll review the performance of Bu’s eight superstar funds in the post-2012 period.

I’ll examine the same four factors (market beta, size, value and momentum) that Bu considered, as well as the funds’ six-factor alpha, adding in the newer factors of quality and low volatility. I used AQR’s factors for consistency purposes. Note this is a relatively short period, raising the hurdle for statistical significance.

 

 

When using the four-factor model, the funds’ average alpha fell from the impressive 3.3% Bu found to just 0.3% in the out-of-sample period. In addition, four of the eight funds generated negative alphas.

The evidence is even worse when using the six-factor model, as the average outperformance totally disappears. Now we find five of the eight funds generated negative alphas in the out-of-sample period.

There’s one more interesting analysis we can perform. We can look at the in-sample performance of the eight winners from the view of a six-factor analysis. It’s important to note that the two additional factors, quality and low beta, were not used in factor analysis prior to 2012.

 

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