Double-Adjusting Mutual Fund Performance for Factors and Stock Characteristics

Summary

This document summarizes a method for evaluating mutual fund managers while accounting for both factor exposures and the characteristics of the stocks held. Its premise is that standard factor models, including the Carhart four-factor model, may leave return variation linked to characteristics such as market capitalization, book-to-market, and momentum. Evaluating funds with factor adjustment alone, or characteristic benchmarks alone, can therefore produce incomplete performance assessments.

The proposed two-stage approach first estimates fund alpha over rolling historical windows, then adjusts for portfolio holding characteristics. One version uses a cross-sectional regression; another groups funds by characteristic exposures and removes the group’s average alpha component. The summary reports that characteristic exposure accounts for a meaningful portion of conventional alpha and that double-adjusted rankings better predict future performance, particularly over shorter horizons. Long-term persistence is weaker. The document summarizes a research paper rather than presenting its underlying data or full specifications, so the results and method depend on the original study’s sample and implementation.

Key ideas

• Factor-adjusted fund returns can remain related to the characteristics of portfolio holdings.
• The method adjusts fund alpha for both factor exposures and stock characteristics.
• A regression approach and a characteristic-grouping approach are presented.
• The summary reports stronger short-term performance persistence under double-adjusted rankings.
• Long-term persistence is described as weaker, and the summary omits the underlying study’s full data and specifications.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.