Abstract
This article studies the impact of market climate on the classic Jensen alpha (JA) of equity funds. We show analytically that the one-factor JA of a fund consists of (i) the fund’s alpha based on the assumed multi-factor model driving fund returns and (ii) further components that are subject to time-dependent market phases of factor realizations. In our empirical study, we analyze JAs and respective fund rankings for a survivorship bias-free data set of 3102 US equity mutual funds. Our results show that factor realizations during the specific lifetime of a fund clearly affect its JA and rank position. This impact of factor realizations is particularly strong for funds with shorter lifetimes. To quantify the market climate impact, we compare classic JAs of funds with their time period-adjusted JAs, removing the influences of market phases. Finally, our main results are robust when applying alternative multi-factor models as return generating process of funds.
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