Academic Papers


Modern Fool’s Gold: Alpha In Recessions

by Shaun A. Pfeiffer and Harold R. Evensky

Using 20 years of monthly mutual fund data, we find active portfolio management fails to add value above the higher costs it imposes on investors. These findings are relevant to both expansions and recessions. However, the empirical results suggest that active portfolio managers, on average, do exhibit enough skill to offset fees in recessions. In other words, the after-expense average returns to active managers in recessions appear to be on an even footing with an index strategy when considering performance alone.

We also find weak persistence in performance across business cycles. Our empirical results suggest weak persistence as seen with the performance rank correlations in Exhibit 5, the contingency table in Exhibit 6, the regression results in Exhibit 7, and the performance of decile portfolios in Exhibit 8. Specifically, the correlation between performance ranks across business cycles is less than 10% in all scenarios examined. The contingency table in Exhibit 6 shows greater than 80% turnover across rank deciles from the 2001 recession to the 2009 recession. Further, Exhibit 7 shows that prior business cycle performance is not a reliable indication of future business cycle performance.

Weak persistence is also explored through the examination of subsequent business cycle performance conditioned upon decile portfolio formation in the 2001 recession. The takeaway from this analysis is that mean reversion appears to dominate persistence effects for each of the decile portfolios. With the exception of the recent expansion that began in July 2009, the four-factor alphas for each decile portfolio tend to cluster around a –1% mean annual alpha. This is consistent with our estimate of market value–weighted alpha across the full sample seen in Exhibit 3. Since the empirical results do not rule out persistence across business cycles, we suggest that future research might explore which fund characteristics, if any, are significantly related to repeat winners and losers across business cycles. In addition, our aggregate findings on mutual fund performance leave the door open to research pertaining to specific active fund family performance across business cycles.

Our empirical results question the pursuit of alpha in both expansions and recessions based on an aggregate inability of active managers to overcome the higher fees imposed on investors. The persistence findings also suggest that a high degree of risk is associated with sustaining performance across different economic conditions.

In sum, the lack of aggregate active portfolio management performance across business cycles and the risk associated with repeat performance should be considered when determining whether a passive or active fund manager is appropriate for the investor.

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