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On Luck versus Skill When Performance Benchmarks are Style-Consistent

53 Pages Posted: 1 Jun 2015  

Andrew Mason

University of Surrey - Surrey Business School

Sam Agyei-Ampomah

Cranfield University - School of Management

Andrew Clare

City University London - Sir John Cass Business School

Steve Thomas

City University London - Sir John Cass Business School

Date Written: April 15, 2015

Abstract

We firmly believe that style-appropriate, investible benchmarks not only provide a more parsimonious way of describing manager performance, but also that their use better aligns performance evaluation with the real world performance targets of fund managers’. It is against such benchmarks that managers should be judged. With this principle foremost in our approach, we use style-consistent benchmarks to determine whether any observed alpha produced by a sample of U.S. equity funds is due to skill or to luck. We find that different segments of the market, ranging from large-cap growth to small-cap value, exhibit different levels of skill and luck. Our results also show that the use of standard multi-factor models underestimates managerial ability and overstates the proportion of funds whose abnormal performance can be attributed to chance rather than to skill, when compared against the use of style-consistent practitioner benchmarks. We also find that a single factor performance evaluation model that uses Russell style indices consistent with the style orientation of a fund and market practice provides a parsimonious way of accounting for fund performance. Finally, our findings should be of particular relevance in mutual fund markets where the risk factors commonly used in the academic literature to evaluate manager performance – SMB, B/M, MOM and others – are not readily available.

Keywords: Mutual fund performance, style benchmarks, skill versus luck

JEL Classification: G1

Suggested Citation

Mason, Andrew and Agyei-Ampomah, Sam and Clare, Andrew and Thomas, Steve, On Luck versus Skill When Performance Benchmarks are Style-Consistent (April 15, 2015). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2612610

Andrew Mason (Contact Author)

University of Surrey - Surrey Business School ( email )

Guildford, Surrey GU2 5XH
United Kingdom
+44-1483-683093 (Phone)

HOME PAGE: http://www2.surrey.ac.uk/management/people/andrew_mason/

Sam Agyei-Ampomah

Cranfield University - School of Management ( email )

Bedfordshire, MK43 0AL
United Kingdom
+441234754375 (Phone)

HOME PAGE: http://www.som.cranfield.ac.uk/som/p19638/People/Faculty/Academic-Faculty-Listing-A-Z/Dr-Sam-Agyei-A

Andrew Clare

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Stephen Thomas

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 (0) 20 7040 5271 (Phone)
+44 (0) 20 7040 8881 (Fax)

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