Electronic copy available at: http://ssrn.

com/abstract=2370501


Jensen alpha and market climate*



Bernhard Breloer
1

Friedrich-Alexander-Universitt (FAU) Erlangen-Nrnberg

Hendrik Scholz
2

Friedrich-Alexander-Universitt (FAU) Erlangen-Nrnberg




This Version: March 17, 2014


1
Bernhard Breloer, Friedrich-Alexander-Universitt (FAU) Erlangen-Nrnberg, Chair of Finance
and Banking, Lange Gasse 20, 90403 Nrnberg, Germany, phone: +49 911 5302 429, fax: +49 911
530 2466, e-mail: bernhard.breloer@fau.de.
2
Hendrik Scholz, Friedrich-Alexander-Universitt (FAU) Erlangen-Nrnberg, Chair of Finance and
Banking, Lange Gasse 20, 90403 Nrnberg, Germany, phone: +49 911 5302 649, fax: +49 911 530
2466, e-mail: hendrik.scholz@fau.de.
* We are grateful to participants of the CFR Research Seminar of the University of Cologne 2008; the
SWFA Annual Meeting 2008, Houston; the EFA Annual Meeting 2008, St. Pete Beach; the 2008
FMA Annual Meeting, Dallas; the Annual Meeting of the German Finance Association 2008,
Mnster; the Annual Meeting of the German Academic Association for Business Research 2009,
Nrnberg; the Southern Finance Association Annual Meeting 2009, Captiva Island; and, especially
to Oliver Entrop, Alexander Kempf, Peter Lckoff, Oliver Schnusenberg, J ohn Stowe, Marco
Wilkens and Wenjuan Xie for helpful comments and suggestions on earlier drafts of this paper
previously titled Ranking of equity mutual funds: The bias in using survivorship bias-free
datasets. We are responsible for any remaining errors.
Electronic copy available at: http://ssrn.com/abstract=2370501


Jensen alpha and market climate

Abstract
This paper studies the impact of market climate on the classic J ensen alpha (J A) of
funds. We show analytically that the one-factor J A of a fund consists of i) the funds
alpha based on the assumed multi-factor model and ii) further components that are
subject to market phases of factor realization. To account for this impact of market
phases in the performance evaluation of funds, we apply a time period-adjusted J A.
In our empirical study, we analyze J As and respective fund rankings for a
survivorship bias-free data set of 3.102 US equity mutual funds. Our results show that
factor realizations during the specific lifetime of a fund clearly affect its rank
position. This impact is particularly strong for funds with shorter lifetimes. Using the
time period-adjusted J A clearly reduces this impact. Our main results are robust when
applying alternative multi-factor models as a return generating process.

Keywords: Equity mutual funds; J ensen alpha; Fund ranking; Market conditions
JEL Classification: G11


1

1. Introduction
When evaluating the performance of equity funds, private and institutional investors
frequently compare fund performance to appropriate benchmarks. Moreover, fund
managers regularly present their performance with a comparison to benchmarks, e.g.,
in the fund prospectus. In this context, the CAPM-based one-factor J ensen alpha
(J ensen, 1968) measures the funds risk-adjusted return, accounting for its systematic
risk exposure related to a selected benchmark. Even today, the classic J ensen alpha
(J A) is still one of the most widely used performance measures (Aragon and Ferson,
2006; Goetzmann et al., 2007). Moreover, it is presented in many finance textbooks
(e.g., Elton et al., 2009; Bodie et al., 2011).
The academic literature suggests that beyond systematic risk, several anomalies in
stock returns should be considered when explaining fund returns. For example, Banz
(1981) describes a size anomaly indicating that small-cap stocks exhibit relatively
high returns. Likewise, Fama and French (1992) discover relatively high returns
among stocks with high book equity to market equity ratios. Consequently, Fama and
French (1993) introduced a three-factor model which contains a size and a value
factor next to the market factor. Then, Carhart (1997) added a momentum factor to the
Fama and French three-factor model based on findings of J egadeesh and Titman
(1993). Until now, the four-factor alpha of the Carhart model has been regularly
applied in the academic literature when evaluating the performance of equity funds.
However, using the one-factor J A can be justified for several reasons. For example,
one could simply neglect potential factors like size, value or momentum factors in
performance models, as these lack a thorough theoretical foundation, e.g., in the
2

context of an equilibrium model such as the CAPM. Moreover, the average investor
could consider fund returns due to exposures to size, value and momentum factors as
the success of the fund manager, since the investor herself might be unwilling or
unable to implement such trading strategies. Furthermore, Berkowitz and Kotowitz
(2000) and Del Guercio and Tkac (2002) document evidence for a positive
relationship between J As and fund flows of US equity funds. Similarly, for Australian
funds Gharghori et al. (2007) find that fund inflows are driven by risk-adjusted
performance, e.g., measured based on J A. On a broader international basis, Ferreira et
al. (2012) confirm a respective positive relationship. These findings indicate the
relevance of J A with respect to evaluating fund performance.
In our analytical study, for the sake of simplicity, we first assume fund returns to
be driven by Carharts (1997) four-factor model. Our first objective is to reveal the
relationship between the one-factor J A and the Carhart four-factor alpha. Based on an
approach outlined in Pastor and Stambaugh (2002), the J A of a fund consists of two
components, these being i) the funds four-factor alpha and ii) the products of the
funds factor exposures to the size, value and momentum factor and the respective
factor alphas. The latter represent the intercepts of regressions of the respective factor
returns on the market factor. On this basis, we show analytically what drives the
difference between a funds J A and its four-factor alpha and discuss how this
difference may impact fund rankings based on these measures.
In a similar context, Krimm et al. (2012) investigate the performance of US equity
mutual funds based on the Sharpe ratio (Sharpe, 1966, 1994). They document that the
Sharpe ratio depends on the market climate of factor realizations. They thus suggest
the use of a normalized Sharpe ratio (Scholz, 2007) to avoid biased rankings of equity
3

funds. Likewise, the classic J A can be subject to market phases of realizations of the
size, the value and the momentum factor.
In the context of evaluating fund performance, empirical studies commonly rely on
survivorship bias-free data to overcome a potential survivorship bias (see, e.g.,
Grinblatt and Titman, 1989; Brown and Goetzman, 1995; Malkiel, 1995; Elton et al.,
1996; Carhart et al., 2002; Rohleder et al., 2011). Including both full-data funds and
non-full-data funds results in datasets with different lengths of fund return history. In
turn, unequal lifetimes of funds can lead to biased performance evaluations, since
these funds are exposed differently to market phases of factor realizations.
Against this background, our second objective is to investigate empirically the J As
of actual equity funds that are exposed to market phases of factor realizations. First,
we document the impact of market climate on the J As of funds and on respective fund
rankings. Second, to avoid a biased performance evaluation, we adjust the factor
alphas of funds if necessary. In detail, we determine the J As the funds would have
shown if they had existed during the full evaluation period. Differences in these time
period-adjusted J As of funds are mainly due to fund-specific characteristics, but not to
the different lifetimes of funds. Before this adjustment, we find that funds with shorter
lifetimes are more strongly affected by the market phases of factor realizations. This
is reflected by larger differences between adjusted J As and classic J As for these
funds.
To test the robustness of our approach, we apply alternative multi-factor models in
this context and find high correlations between adjusted J As based on these models
and adjusted J As based on the Carhart model. Thus the choice of the respective multi-
4

factor model used to explain fund returns does not seem to severely impact our
empirical results.
The remainder of this paper is organized as follows. Section 2 describes the applied
performance measures and the methodology for time period adjustments of the J A.
Section 3 presents the fund sample used as well as our empirical results explaining the
relationship between J A, lifetime of funds and market phases of factor realizations.
After applying the time period adjustment of the J ensen alpha, we investigate the
difference between adjusted J As and the classic J As and its impacts on respective
fund rankings. Finally, Section 4 concludes.
2. Jensen alpha and the market phases of factor alphas
In this study, we investigate how market phases of factor realizations impact the J A.
The classic one-factor J A of fund i is determined by regressing its monthly return in
excess of the risk free rate ER
it
on the monthly market excess return ERM
t
,
ER
it
=
i
1F
+
i
1F
ERM
t
+
i t
, (1)
where the funds J A is the constant term
i
1F
in Equation (1), and
i
1F
denotes the
funds systematic risk.
As a second measure, we apply the four-factor alpha according to the Carhart
(1997) model, which additionally includes a size factor SMB, a value factor HML and
a momentum factor MOM to Equation (1),
ER
it
=
i
4F
+
1i
4F
ERM
t
+
2i
4F
SMB
t
+
Si
4F
HML
t
+
4i
4F
MOM
t
+
i t
,

(2)
5

where the funds four-factor alpha is the constant term
i
4F
and the exposures to the
factors ERM, SMB, HML and MOM are represented by
1i
4F
,
2i
4F
,
Si
4F
and
4i
4F
,
respectively. In the following, for the sake of simplicity, we first assume Carharts
four-factor model to be the return generating process of funds, which accounts for
potential investment opportunities represented by the factors SMB, HML and MOM.
Omitting SMB, HML and MOM in the one-factor regression model can lead to
potential differences between the J A and the four-factor alpha of a fund. To display
these differences, we now apply an approach outlined in Pastor and Stambaugh
(2002). According to Equation (1), we first regress each of the factors SMB, HML
and MOM

on the market excess return ERM.
SMB
t
=
smb
1F
+
smb
1F
ERM
t
+
smb t
(3)
HML
t
=
hml
1F
+
hml
1F
ERM
t
+
hml t
(4)
MOM
t
=
mom
1F
+
mom
1F
ERM
t
+
mom t
(5)
We call the intercepts of these regressions factor alphas (
smb
1F
,
hml
1F
and
mom
1F
). For
each fund, these factor alphas are estimated based on an evaluation period according
to the fund-specific lifetime. Thus factor alphas of funds differ when the funds exhibit
different lifetimes.
Next, we substitute SMB
t
, HML
t
and MOM
t
in Equation (2) on the right hand side
of Equations (3) to (5), which reveals - after some rearrangement - the components of
the one-factor J A as follows:
6

i
1F
=
i
4F
+
2i
4F

smb
1F
+
Si
4F

hml
1F
+
4i
4F

mom
1F
(6)
Accordingly, the J A of a fund i consists of its four-factor alpha and the sum of the
fund-specific factor contributions of SMB, HML and MOM. For example, the
contribution of the SMB factor equals the funds exposure to the SMB factor times
the SMB factor alpha.
Importantly, while a funds factor exposures on SMB, HML and MOM depend on
its investment style, factor alphas are not identical across funds with regard to fund-
specific lifetimes and hence are sensitive to market climate. Therefore, two funds with
identical four-factor alphas and identical factor exposures to SMB, HML and MOM,
but different lifetimes, may have different J As due to different fund-specific factor
alphas. In turn, evaluating the performance of funds with different lifetimes can result
in a biased J A comparison, e.g., a biased J A fund ranking.
Thus to appropriately compare the performance of funds based on J A, we treat
funds as if they are exposed to the same market phases of the respective factors, i.e.,
to the same factor alphas. Hence we adjust the J A of each fund i by replacing the
fund-specific factor alphas in Equation (6) by full-period factor alphas
smb
1F_FP
,
hml
1F_FP

and
mom
1F_FP
each estimated over the full evaluation period.
1

i
1F_auj
=
i
4F
+
2i
4F

smb
1F_FP
+
Si
4F

hml
1F_FP
+
4i
4F

mom
1F_FP
(7)
where
i
1F_auj
represents the time period-adjusted J A of fund i.

1
Alternatively, even longer time periods could be considered to estimate normal factor alphas that
contain no market climate impact (compare, e.g., Pastor and Stambaugh, 2002; Krimm et al., 2012).
7

By subtracting Equation (6) from Equation (7), the adjusted J A of fund i equals its
classic J A plus the sum of differences between full-period adjusted and original factor
contributions of the fund.

i
1F_auj
=
i
1F
+
2i
4F
(
smb
1F_FP

smb
1F
) +
Si
4F
(
hml
1F_FP

hml
1F
) +
4i
4F
(
mom
1F_FP

mom
1F
) (8)
According to Equation (8), the adjusted J A is lower than the classic J A, if the sum of
differences between the full-period adjusted and original factor contributions is
negative and vice versa.
3. Empirical analysis
3.1 Data and summary statistics
As the source of fund data, we use the mutual fund database from the Center for
Research in Securities Prices (CRSP). We select U.S. domestic equity mutual funds
for an evaluation period from J anuary 1996 to December 2009.
2
From this sample, we
eliminate funds with the description of ETF, Index, Long-Short, Alpha-Only, Fixed
Income, Retirement, Variable Insurance or Target in their names (compare, e.g.,
Comer et al., 2009; Amihud and Goyenko, 2013; Breloer et al., 2014). If a fund offers
multiple share classes, we select the oldest one. For the remaining funds we extract
monthly returns. Moreover, we require funds to exhibit at least 36 months of
continuous monthly returns. To avoid data-errors and outliers, we eliminate all funds
with fragmentary return histories and with implausible monthly returns greater than

2
We choose funds with the following Lipper objective codes: Capital appreciation funds (CA), equity
income funds (EI), growth funds (G), growth and income funds (GI), mid-cap funds (MC), and
small-cap funds (SG). For fund selection, we rely on the most recent objective code.
8

100 percent or less than 100 percent. Our final data set contains 3,102 domestic
equity funds.
Table 1 shows the total yearly number of funds as well as the number of annual
fund starts and disappearances.
3
Basically, we find that the number of funds almost
continuously increases, peaking at the end of 2006 (2,283 funds). Since 1999, funds
disappear from our sample while new funds enter. Thus the lifetimes of funds in our
fund sample differ.
Insert Table 1 about here
To account for different lifetimes of funds, we divide our fund sample as follows.
The first subsample contains those funds that exist throughout the full evaluation
period, so called full-data funds (FD funds). The remaining non-full-data funds
are sorted into three subsamples based on the length of their return histories: a long
lifetime sample (LLT funds), a medium lifetime sample (MLT funds) and a short
lifetime sample (SLT funds). In total, we count 638 FD funds, 829 LLT funds, 819
MLT funds and 816 SLT funds. On average, FD (LLT, MLT, SLT) funds have a
lifetime of 168 (136, 88, 51) months.
In this context, Figure 1 shows the monthly number of funds in our subsamples.
The number of LLT funds increases until the end of 2000, remains on the same level
until the start of 2005 (829 funds) and decreases thereafter. MLT funds show a similar
pattern. That is, most MLT funds exist from December 2000 to December 2004
(about 570 funds on average). In contrast, SLT funds exhibit a relatively high number
of funds during the last third of the evaluation period. On average, we count about 170

3
Since each fund has at least 36 months of monthly returns, no funds disappear in the first three years
and no new funds start after January 2007.
9

SLT funds from December 1996 to December 2004, while more than 350 SLT funds
exist from J anuary 2005 to December 2009.
Insert Figure 1 about here
To analyze the performance of our funds, we use monthly excess returns of the
market ERM and the factors SMB, HML and MOM.
4
Table 2 presents descriptive
statistics for the four factors and factor alphas according to Equations (3) to (5). The
factors ERM, SMB, HML and MOM exhibit positive but not statistically significant
monthly means measuring 0.38, 0.26, 0.35 and 0.44, respectively. Similar, monthly
factor alphas of SMB, HML and MOM are positive but statistically not significant,
measuring 0.192, 0.428 and 0.596, respectively. Moreover, the four factors exhibit
low correlations, measuring between 0.39 and 0.23, which is also reflected by low
variance inflation factors (VIF) of about 1.3. Thus, multicollinearity should not be a
concern.
Insert Table 2 about here
Focusing on the variation of factor alphas over time, Figure 2 shows the SMB,
HML and MOM factor alphas based on a 12-month rolling window. In general,
monthly factor alphas vary largely. For example, the SMB factor alpha is often
negative during the period from 1996 to 1999, but shows large fluctuations.
Conversely, from 2000 to 2004 it is mostly positive, exhibiting lower variability.
Similarly, the HML and MOM factor alphas clearly show variations over time.
Insert Figure 2 about here

4
The monthly factor and T-bill returns are downloadable from Kenneth Frenchs website
(http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html), which also contains
information about the factor construction.
10

To illustrate the variation in factor alphas during the individual lifetimes of our
non-full-data funds, Figure 3 shows absolute frequencies of factor alphas for our
subsamples of LLT, MLT and SLT funds. In addition, the bold vertical lines indicate
the respective full-period factor alphas of SMB, HML and MOM. Referring to LLT
funds in Panel A, their factor alphas vary only slightly with respect to full-period
factor alphas. Particularly, SMB and HML factor alphas of LLT funds are exclusively
positive. In comparison, factor alphas of SLT funds in Panel C vary clearly around
full-period factor alphas. Thus, SLT funds exhibit larger shares of negative SMB and
MOM factor alphas as well as relatively high positive SMB and MOM factor alphas.
Figure 3 about here
Against the background of these findings, we expect these differences in factor
alphas to impact J A fund rankings. In the next Section 3.2, we therefore investigate
the relationship between J As, lifetime of funds and factor contributions.
3.2 Jensen alpha, four-factor alphas and factor contributions
We now take a closer look at descriptive statistics and factor alphas for our fund
subsamples. Table 3 shows average J As, alphas and betas of the four-factor model and
corresponding standard deviations for the cross-sections of FD, SLT, MLT and LLT
funds. In addition, the average factor alphas for each fund subsample are presented.
Focusing on the FD fund sample in Panel A, J As are positive on average, measuring
0.025%, while four-factor alphas are negative, measuring 0.045%. Furthermore, the
cross-sectional standard deviation of J As is higher than that of four-factor alphas.
Noteworthy is the difference between J As and four-factor alphas of FD funds, which
is driven solely by variation in the funds factor exposures, as the factor alphas of all
11

FD funds coincide with the full-period factor alphas. Hence, based on Equation (6),
funds with exclusively negative factor exposures exhibit higher four-factor alphas and
vice versa given the positive SMB, HML and MOM factor alphas during the lifetime
of FD funds.
Focusing on LLT, MLT and SLT funds, in Panel B, C and D we observe lower
four-factor alphas compared to FD funds. Given the disappearance of many funds,
particularly in the SLT fund subsample, the relatively high performance of FD funds
could be due to a survivorship bias (see, among others, Brown and Goetzman, 1995;
Elton et al., 1996; Rohleder et al., 2011). Furthermore, these subsamples exhibit
higher cross-sectional standard deviations of four-factor alphas compared to FD
funds.
In contrast to FD funds, the difference between J As and four-factor alphas of LLT,
MLT and SLT funds is not only driven by the variation in fund-specific factor
exposures, but also by different factor alphas during the funds lifetimes. While the
average factor exposures of all four subsamples are similar, cross-sectional means and
standard deviations of factor alphas based on funds lifetimes differ considerably
among the subsamples (see also Figure 3). For example, the SMB factor alphas of
LLT funds show a mean and a standard deviation of 0.318% and 0.145%,
respectively, while for SLT funds these numbers are 0.246% and 0.436%,
respectively. Thus, the J As of SLT funds tend to be more affected by variations in the
SMB factor alphas. We have similar findings regarding HML and MOM factor
alphas.
Insert Table 3 about here
12

While the factor exposures of our fund subsamples tend to be similar on average,
their factor alphas clearly differ. These should be reflected in variations in the
corresponding factor contributions to the J A. Thus we now focus on the relationship
between J As and four-factor alphas with respect to factor contributions as outlined in
Equation (6). Positive factor contributions result in higher J As compared to the four-
factor alphas and vice versa. As the majority of funds exist during positive market
phases of factor alphas, the sign of factor contributions is mostly affected by the sign
of the funds factor exposures. Therefore, we first split each fund subsample, based on
the sign of the funds SMB exposures, into a positive and a negative SMB exposure
group. Similarly, we group funds with respect to their HML and MOM exposures for
each subsample. Table 4 reports the cross-sectional averages of J As, four-factor
alphas and corresponding factor contributions for our four subsamples in Panels A
to D.
In Panel A of Table 4, we observe that FD funds with positive SMB exposures
exhibit an average J A of 0.078%. Therefore, in line with Equation (6) and our
expectations, J As mainly corresponds to the sum of the four-factor alphas of 0.036%
and the positive SMB factor contribution of 0.071%. Additionally, positive HML and
MOM factor contributions further increase the positive difference between the
average J A and four-factor alpha for this fund group. While we expect opposite
results for FD funds with negative SMB exposure, on average, these funds exhibit a
slightly higher J A (0.044%) than four-factor alpha (0.056%). Here, the negative
SMB factor contribution of 0.024% is more than compensated by the positive HML
factor contribution of 0.047%, resulting in an overall positive factor contribution.
Findings for the FD funds group with positive (negative) HML exposures reveal that,
13

on average, the positive (negative) HML factor contribution results in a higher (lower)
J A compared to the four-factor alpha. In contrast, FD funds with negative MOM
exposure show a higher J A compared to the four-factor alpha, as the negative MOM
factor contribution is overcompensated by a positive HML factor contribution.
Since the lifetimes of non-full-data funds differ, in Panels B to D we now also
account for variations in factor alphas. That is, we further sort funds in each non-full-
data subsample into fund groups with high or with low SMB factor alphas. If the
SMB factor alpha during the fund-specific lifetimes is higher (lower) than the full-
period SMB factor alpha, the fund is sorted into the high (low) SMB factor alpha
group. In Panel B of Table 4, we observe for LLT funds in the high SMB factor alpha
group that funds with positive SMB exposures show, as expected, average J As higher
than corresponding four-factor alphas. This positive difference is largely driven by a
positive SMB factor contribution. In contrast, funds with negative SMB exposure
exhibit lower J As than corresponding four-factor alphas, as expected, mainly due to
negative SMB factor contributions. Furthermore, we observe comparable findings for
funds in the low SMB factor alpha group as well as for respective groups of funds
based on HML and MOM factor alphas and corresponding exposures. Moreover,
results for MLT funds are largely in line with LLT funds (see Panel C). Importantly,
on average, LLT and MLT funds show higher absolute factor contributions than FD
funds, due to variations in factor alphas.
Regarding the SLT funds in Panel D, we document for the high factor alpha fund
groups that funds with positive factor exposures show among the highest factor
contributions. Conversely, SLT funds in the low factor alpha groups have minor
factor contributions, as these groups are exposed to small factor alphas on average
14

(compare Figure 3).
5
In addition, the SMB and MOM factor alphas of these SLT fund
groups are negative on average (compare Figure 3). Therefore, respective groups with
positive factor exposures have negative factor contributions and lower J As compared
to four-factor alphas. Accordingly, SLT funds with positive factor exposures exhibit
higher J As than four-factor alphas due to positive factor contributions.
Insert Table 4 about here
In short, differences between J As and four-factor alphas are substantially
influenced by variations in factor contributions which are driven by factor alphas
during the funds lifetimes. In particular, the factor contributions of SLT funds
substantially vary due to the market phases of factor alphas.
3.3 Time period adjustment of Jensen alpha
So far, we have observed that the J As of our fund subsamples are differently affected
by factor contributions. After accounting for the sign of factor exposures, this is
mainly caused by market phases of factor alphas. To eliminate the market climate
impact on J As, we now control for fund-specific factor alphas by replacing those with
full-period factor alphas. Consequently, we determine the adjusted J A

for each fund
according to Equation (7). As result, we expect adjusted J As of funds in the high
factor alpha fund groups to be lower (higher) than the classic J As given positive
(negative) factor exposures. Since LLT funds mainly consist of funds with factor
alphas closer to full-period factor alphas, the J As of this subsample should be less
affected by time period adjustments. In contrast, J As of SLT funds should

5
In results not reported, we find that factor alphas are the higher (lower) for SLT funds in the high
(low) factor alpha groups compared to corresponding LLT and MLT fund groups. These results are
available from the authors upon request.
15

substantially change due to time period adjustments, as the factor alphas during their
lifetimes deviate substantially with respect to full-period factor alphas (see Section
3.2).
We sort LLT, MLT and SLT funds into the same fund groups as in Section 3.2.
Based on Equation (8), Table 5 refers to the adjusted J A, the classic J A and the
differences between adjusted and original factor contributions of LLT, MLT and SLT
fund groups in Panel A, B and C, respectively. In line with expectations, LLT funds
with positive SMB exposures in the high factor alpha group exhibit smaller adjusted
J As (0.109%) than corresponding J As (0.161%). This is mainly caused by a
downward adjustment of the SMB factor contribution (0.059%). For funds with
negative SMB exposure, a positive adjustment of the SMB factor contribution
(0.021%) leads to a higher adjusted J A

(0.049%). However, funds in the low factor
alpha group with positive HML (MOM) exposure also exhibit lower adjusted J As.
This is because the positive adjustment of the HML (MOM) contribution of 0.016%
(0.026%) is exceeded by a negative adjustment of the SMB factor contribution of
0.026% (0.046%). For MLT funds in Panel B and SLT funds in Panel C, we find
that the differences between adjusted J As and classic J As are mostly in line with our
expectations. Not surprisingly, most substantial are observed for the groups
containing SLT funds. For example, for SLT funds with positive SMB exposures in
the high factor alpha group, the difference on average between adjusted J A and J A

measures 0.16%. Thus, strong deviations in factor alphas lead to substantial
adjustments in factor contributions and hence to adjustments in J As.
Insert Table 5 about here
16

One conclusion drawn from these findings is that comparing funds based on the
classic J A can result in biased fund rankings as soon as the investigated funds exhibit
different lengths of return history. To illustrate differences in fund rankings for our
fund subsamples, we present scatter plots similar to Bollen and Whaley (2009).
Therefore, we plot rank positions of funds based on adjusted J As and J As in one
diagram.
Figure 4 shows respective scatter plots for all funds as well as for the subsamples
of FD, LLT, MLT and SLT funds. In addition, corresponding mean absolute rank
changes (MARC) are reported. In the case of identical rank positions, coordinates of
funds would be located exactly on the bisecting line. For all funds in Panel A, we
observe that a larger share of funds is distributed closely to the bisecting line but
several funds are still widely dispersed. Against this background, FD funds in Panel B
and LLT funds in Panel C show relatively few differences in rank between those
based on adjusted J A and those based on J A. Since factor alphas of LLT funds are
only slightly adjusted, LLT funds exhibit an average MARC of only 163.5 ranks.
Importantly, the positions of SLT funds clearly deviate from the bisecting line
reflected by a relatively high average MARC of 357.9 ranks (see Panel E). Thus we
conclude that in this subsample, rank positions of funds based on the classic J A are
clearly influenced by market climate.
Insert Figure 4 about here
3.4 Robustness: Augmented factor models
Until now, our analysis is based on the assumption that the Carhart four-factor model
represents the return generating process of funds. However, recent literature offers
17

alternative models that take additional performance factors into account. In the
following, we thus study whether our results are affected by choosing augmented
multi-factor models as the assumed return generating process of funds.
Taking the Carhart four-factor model (Model 1) as the point of departure, there are
several performance factors which could additionally be considered. For example,
Pastor and Stambaugh (2003) document that expected returns of stocks are sensitive
to market liquidity and suggest the use of a liquidity factor. Furthermore, Frazzini and
Petersen (2013) show that assets with high market exposure produce relatively low
alphas compared to assets with low market exposure. Consequently, they introduce a
so-called betting-against-beta (BAB) factor. Moreover, Asness et al. (2013) find high
quality stocks to exhibit higher risk-adjusted returns than low quality stocks. To
account for this potential anomaly, they introduce a quality-minus-junk (QMJ ) factor
which may help to better explain stock returns. We consider these three potential
performance factors and hence augment the Carhart four-factor model either with a
liquidity, a BAB or a QMJ factor, resulting in three respective five-factor models
(Models 2 to 4).
6
Finally, we include these three additional factors at the same time,
resulting in a seven-factor model (Model 5).
Panel A of Table 6 presents Pearson correlations between adjusted J As based on
the Models 1 to 5, respectively, which measure from 0.919 to 0.997. Likewise,
respective Spearman rank correlations in Panel B range between 0.907 and 0.997.
These high correlations indicate that the use of the Carhart (1997) four-factor model

6
The monthly return of the liquidity factor is downloadable from Lubos Pastors website
(http://faculty.chicagobooth.edu/lubos.pastor/research/), which also contains information about the
factor construction. The monthly returns of the BAB and QMJ factors are downloadable from Andrea
Frazzinis website (http://www.econ.yale.edu/~af227/data_library.htm), which also contains
information about the factor construction.
18

as return generating process of funds is quite robust against the application of these
alternative multi-factor models.
Insert Table 6 about here
4. Summary and conclusion
Our theoretical and empirical analyses indicate that using the classic J A to measure
and compare fund performance for a survivorship bias-free dataset can result in a
biased comparison. Different realizations of factor alphas during fund-specific
lifetimes result in varying factor contributions to the J A and thus impact respective
fund rankings.
To illustrate the impact of market phases of factor alphas on J A with respect to
lifetime of funds, we group funds based on the length of their return histories. We use
the Carhart four-factor model as the return generating process and show that
differences between the four-factor alphas and J As of funds are driven by their SMB,
HML and MOM factor contributions. In detail, after accounting for the sign of the
factor exposures, factor contributions are driven by factor alphas and their respective
market phases. This is particularly the case for funds with short return histories. To
reduce the impact of market climate on factor contributions, we suggest standardizing
the evaluation period for all funds by replacing fund-specific factor alphas with full-
period factor alphas. We thus determine the J A which funds would have shown if they
had existed during the full evaluation period. This adjustment of factor alphas and
factor contributions has a stronger impact on funds with shorter return histories,
causing larger differences between adjusted J As and corresponding classic J As.
Against this background, fund rankings based on J A (instead of adjusted J A) are
19

influenced by fund-specific factor alphas which can thus result in misleading
conclusions about the performance of the investigated fund sample. Comparing
correlations between adjusted J As based on the Carhart four-factor model and based
on four augmented multi-factor models, our findings indicate only minor differences
and hence underline the robustness of our empirical results.
The findings reported here are not only important to researchers concerned with
fund performance and ranking, but also to investors and analysts comparing the
performance of individual funds. Moreover, our results are also useful for investment
company boards when rewarding fund managers for their performance relative to
others. Regarding future research, several possible directions emerge from these
results. In the context of empirical studies, the use of time period-adjusted alphas
could be applied to funds investing in different asset classes. Moreover, the approach
of adjusting J A could be transferred to other popular performance measures like the
Information ratio.
20

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2
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Elton, E.J ., Gruber, M.J ., Brown, J .S., Goetzmann, W.N., 2009. Modern Portfolio
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49-58.

23
Table 1: Yearly total numbers, starts and disappearances of funds
This table shows the total numbers of funds as well as the numbers of annual fund
starts and disappearances within the evaluation period fromJ anuary 1996 to December
2009. Total number refers to the number of funds operating at the end of each year.


Funds
Year


Total number Starts Disappearances

1995 1,097
1996 1,271 174
1997 1,500 229
1998 1,737 237
1999 1,946 213 4
2000 2,101 232 77
2001 2,198 173 76
2002 2,241 138 95
2003 2,219 120 142
2004 2,217 132 134
2005 2,260 190 147
2006 2,283 145 122
2007 2,174 22 131
2008 2,049 125
2009 1,849 200



24
Table 2: Descriptive statistics of factors
This table shows descriptive statistics for the monthly explanatory factors. The evaluation period is fromJ anuary 1996 to
December 2009. Monthly factor alphas are estimated based on Equation (1). Means and factor alphas are reported in percent. STD
refers to the standard deviation of monthly returns. VIF refers to the variance inflation factor. Numbers in brackets represent
t-statistics that are based on the null hypothesis H
o
: x =0.
Factor Mean STD
Factor
alpha
VIF


Correlation


ERM SMB HML MOM

ERM 0.38 0.049 1.32 1
(1.02)
SMB 0.26 0.039 0.192 1.21 0.23 1
(0.87) (0.65)
HML 0.35 0.037 0.428 1.31 0.28 0.39 1
(1.20) (1.54)
MOM 0.44 0.062 0.596 1.23 0.33 0.08 0.16 1
(0.92) (1.32)



25
Table 3: Descriptive statistics of fund subsamples
This table shows cross-sectional means and standard deviations (STD) of one-factor J ensen alphas as well as alphas and betas of the four-
factor model for four fund subsamples. In addition, the table presents cross-sectional means and STD of corresponding factor alphas based
on fund lifetimes. Funds are first sorted into full-data funds (FD funds) and non-full-data funds. Non-full-data funds are then allocated to
three subsamples based on the length of fund return histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes.
Monthly (factor) alphas and STD are reported in percent.

1F-model 4F-model
Factor alpha
during fund lifetime

1F
adj. R
2

4F

1
4F

2
4F

3
4F

4
4F
adj. R
2

smb
1F

hml
1F

mom
1F


Panel A: FD funds
Mean 0.025 0.767 0.045 0.965 0.152 0.084 0.007 0.871 0.192 0.428 0.596
STD 0.199 0.113 0.173 0.161 0.311 0.315 0.106 0.071

Panel B: LLT funds
Mean 0.034 0.767 0.052 0.988 0.16 0.052 0.024 0.873 0.318 0.533 0.549
STD 0.305 0.129 0.242 0.146 0.314 0.337 0.125 0.076 0.145 0.159 0.334

Panel C: MLT funds
Mean 0.072 0.801 0.150 0.997 0.194 0.015 0.019 0.887 0.313 0.492 0.509
STD 0.319 0.139 0.272 0.171 0.337 0.319 0.126 0.090 0.191 0.249 0.562

Panel D: SLT funds
Mean 0.121 0.804 0.155 1.001 0.194 0.005 0.001 0.889 0.246 0.298 0.165
STD 0.477 0.166 0.393 0.183 0.337 0.321 0.153 0.102 0.436 0.371 0.825


26
Table 4: Components of Jensen alpha
This table shows average one-factor J ensen alphas, four-factor alphas and factor contributions for four fund subsamples. Funds are first
sorted into full-data funds (FD funds) and non-full-data funds. Non-full-data funds are then allocated to three subsamples based on the length
of fund return histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes. Fund subsamples are further divided by
positive factor exposure and negative factor exposure (for each of the factors SMB, HML and MOM). In addition, LLT, MLT and SLT funds
are sorted based on the factor alpha of funds being higher than the corresponding full-period factor alpha (high factor alpha) or lower than the
corresponding full-period factor alpha (low factor alpha). Monthly alphas and factor contributions are reported in percent.



1F



4F



2
4F

smb
1F



S
4F

hml
1F



4
4F

mom
1F


Panel A: FD funds








pos. SMB 0.078

0.036

0.071

0.027

0.016
neg. SMB 0.044

0.056

0.024

0.047

0.011

pos. HML 0.075

0.048

0.022

0.122

0.021
neg. HML 0.058

0.039

0.040

0.104

0.045

pos. MOM 0.010

0.076

0.043

0.030

0.053
neg. MOM 0.059

0.014

0.016

0.101

0.044

Panel B: LLT funds








High factor alpha








pos. SMB 0.161

0.018

0.129

0.023

0.028
neg. SMB 0.066

0.043

0.044

0.031

0.010

pos. HML 0.105

0.085

0.039

0.173

0.022
neg. HML 0.146

0.083

0.052

0.158

0.044

pos. MOM 0.117

0.193

0.052

0.085

0.108
neg. MOM 0.112

0.125

0.002

0.082

0.071

Low factor alpha








pos. SMB 0.074

0.164

0.059

0.018

0.049
neg. SMB 0.152

0.136

0.017

0.033

0.032

pos. HML 0.160

0.003

0.063

0.109

0.009
neg. HML 0.040

0.015

0.065

0.097

0.057

pos. MOM 0.104

0.008

0.096

0.021

0.036
neg. MOM 0.136

0.028

0.029

0.106

0.027

Panel C: MLT funds








High factor alpha








pos. SMB 0.027

0.150

0.150

0.011

0.017
neg. SMB 0.172

0.130

0.049

0.016

0.009

pos. HML 0.013

0.218

0.050

0.200

0.045
neg. HML 0.279

0.236

0.076

0.191

0.073

pos. MOM 0.176

0.296

0.074

0.095

0.140
neg. MOM 0.150

0.199

0.014

0.122

0.087

Low factor alpha






pos. SMB 0.155

0.222

0.041

0.016

0.042
neg. SMB 0.128

0.097

0.013

0.006

0.024

pos. HML 0.062

0.049

0.062

0.048

0.002
neg. HML 0.035

0.052

0.059

0.052

0.010

pos. MOM 0.019

0.094

0.091

0.023

0.006
neg. MOM 0.044

0.034

0.064

0.015

0.001

Panel D: SLT funds








High factor alpha








pos. SMB 0.040

0.181

0.220

0.034

0.035
neg. SMB 0.192

0.104

0.088

0.006

0.007

pos. HML 0.007

0.225

0.028

0.255

0.052
neg. HML 0.361

0.302

0.118

0.224

0.046

pos. MOM 0.036

0.204

0.059

0.058

0.167
neg. MOM 0.256

0.182

0.023

0.092

0.142

Low factor alpha








pos. SMB 0.163

0.159

0.007

0.021

0.019
neg. SMB 0.156

0.162

0.003

0.030

0.026

pos. HML 0.214

0.208

0.001

0.028

0.033
neg. HML 0.005

0.020

0.030

0.018

0.014

pos. MOM 0.150

0.139

0.056

0.036

0.031
neg. MOM 0.035

0.127 0.035 0.031 0.027


27
Table 5: Time period adjustment of Jensen alpha
This table shows average time period-adjusted J ensen alphas, J ensen alphas and differences between full-period adjusted- and original factor
contributions for non-full-data fund subsamples. Non-full-data funds are sorted into three subsamples based on the length of fund return
histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes. Fund subsamples are further divided by positive factor
exposure and negative factor exposure (for each of the factors SMB, HML and MOM). In addition, LLT, MLT and SLT funds are sorted
based on the factor alpha of funds being higher than the corresponding full-period factor alpha (high factor alpha) or lower than the
corresponding full-period factor alpha (low factor alpha). Monthly alphas and differences in factor contributions are reported in percent.



1F_auj

1F



2
4F
(
smb
1F_FP

smb
1F
)
S
4F
(
hml
1F_FP

hml,
1F
)
4
4F
(
mom
1F_FP

mom
1F
)

Panel A: LLT funds







High factor alpha






pos. SMB 0.109

0.161 0.059 0.001 0.006
neg. SMB 0.049

0.066

0.021 0.004 0.000

pos. HML 0.049

0.105 0.017 0.051 0.011
neg. HML 0.118 0.146

0.023 0.054 0.003

pos. MOM 0.131

0.117 0.006 0.029 0.038
neg. MOM 0.108 0.112

0.000 0.020 0.025

Low factor alpha


pos. SMB 0.062

0.074 0.016 0.012 0.015
neg. SMB 0.156

0.152

0.006 0.009 0.010

pos. HML 0.148

0.160 0.026 0.016 0.002
neg. HML 0.008

0.040

0.021 0.013 0.001

pos. MOM 0.085

0.104 0.046 0.001 0.026
neg. MOM 0.100 0.136

0.013 0.009 0.015

Panel B: MLT funds
High factor alpha


pos. SMB 0.043

0.027 0.076 0.000 0.006
neg. SMB 0.141

0.172

0.025 0.001 0.006

pos. HML 0.086

0.013 0.023 0.072 0.022
neg. HML 0.266

0.279

0.036 0.072 0.022

pos. MOM 0.234

0.176 0.028 0.031 0.061
neg. MOM 0.155

0.150

0.001 0.042 0.038

Low factor alpha


pos. SMB 0.151

0.155 0.037 0.009 0.024
neg. SMB 0.124

0.128

0.013 0.003 0.014

pos. HML 0.066

0.062 0.024 0.029 0.002
neg. HML 0.070 0.035

0.012 0.036 0.014

pos. MOM 0.012

0.019 0.043 0.006 0.044
neg. MOM 0.012 0.044

0.022 0.005 0.038

Panel C: SLT funds
High factor alpha


pos. SMB 0.120

0.040 0.151 0.000 0.009
neg. SMB 0.124

0.192

0.065 0.003 0.000

pos. HML 0.100

0.007 0.005 0.110 0.009
neg. HML 0.325

0.361

0.080 0.108 0.008

pos. MOM 0.131

0.036 0.019 0.006 0.081
neg. MOM 0.135

0.256

0.048 0.005 0.066

Low factor alpha
pos. SMB 0.084

0.163 0.082 0.017 0.014
neg. SMB 0.167

0.156

0.024 0.001 0.012

pos. HML 0.099

0.214 0.039 0.071 0.006
neg. HML 0.053

0.005

0.012 0.075 0.004

pos. MOM 0.078

0.150 0.013 0.001 0.084
neg. MOM 0.137 0.035 0.004 0.028 0.078





28
Table 6: Rank correlation between adjusted Jensen alphas
This table presents Pearson correlations and Spearman rank correlations of funds between time period-adjusted J ensen alphas (JA
adj
) based
on several multi-factor models. The evaluation period is fromJ anuary 1996 to December 2009. Model 1 is the Carhart four-factor model.
Model 2 refers to a five-factor model that additionally includes a liquidity factor (Pastor and Stambaugh, 2003). Model 3 represents a five-
factor model that additionally contains a betting-against-beta factor (Frazzini and Petersen, 2013). Model 4 refers to a five-factor model that
augments the Carhart model by a quality-minus-junk factor (Asness et al., 2013). Model 5 is a seven-factor model that contains the four
factors of the Carhart model as well as the liquidity, the betting-against-beta and the quality-minus-junk factors.
J A
adj
(M1) J A
adj
(M2) J A
adj
(M3) J A
adj
(M4) J A
adj
(M5)

Panel A: Pearson correlation
J A
adj
(M1) 1
J A
adj
(M2) 0.997 1
J A
adj
(M3) 0.967 0.969 1
J A
adj
(M4) 0.941 0.940 0.919 1
J A
adj
(M5) 0.953 0.954 0.962 0.948 1

Panel B: Spearman rank correlation
J A
adj
(M1) 1
J A
adj
(M2) 0.997 1
J A
adj
(M3) 0.961 0.963 1
J A
adj
(M4) 0.927 0.926 0.907 1
J A
adj
(M5) 0.941 0.941 0.951 0.943 1



29

Figure 1: Monthly number of funds in subsamples

This figure shows the monthly number of funds in four subsamples. The evaluation period is fromJ anuary 1996 to December 2009. The
funds are first sorted into full-data funds (FD funds) and non-full-data funds. Non-full-data funds are then allocated to three subsamples
based on the length of fund return histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes.
0
100
200
300
400
500
600
700
800
900
1
2
.
1
9
9
6
1
2
.
1
9
9
7
1
2
.
1
9
9
8
1
2
.
1
9
9
9
1
2
.
2
0
0
0
1
2
.
2
0
0
1
1
2
.
2
0
0
2
1
2
.
2
0
0
3
1
2
.
2
0
0
4
1
2
.
2
0
0
5
1
2
.
2
0
0
6
1
2
.
2
0
0
7
1
2
.
2
0
0
8
1
2
.
2
0
0
9
FD funds (638) LLT funds (829) MLT funds (819) SLT funds (816)
30


Figure 2: Rolling 12-month factor alphas

This figure presents monthly rolling 12-month factor alphas stemming fromregressions of the monthly factors SMB, HML and MOM on the
market excess return ERM according to Equation (1). The evaluation period is fromJ anuary 1996 to December 2009. The first window
ranges fromJ anuary 1996 to December 1996. The horizontal axis indicates the end dates of the respective rolling windows. Monthly factor
alphas are reported in percent.
-8
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
4
1
2
.
1
9
9
6
1
2
.
1
9
9
7
1
2
.
1
9
9
8
1
2
.
1
9
9
9
1
2
.
2
0
0
0
1
2
.
2
0
0
1
1
2
.
2
0
0
2
1
2
.
2
0
0
3
1
2
.
2
0
0
4
1
2
.
2
0
0
5
1
2
.
2
0
0
6
1
2
.
2
0
0
7
1
2
.
2
0
0
8
1
2
.
2
0
0
9
SMB factor alpha HML factor alpha MOM factor alpha
31


Figure 3: Frequencies of factor alphas for different fund subsamples

This figure shows the absolute frequencies of factor alphas with respect to each fund subsample and the factors SMB, HML and MOM.
Factor alphas stemfromregressing the factors SMB, HML and MOM on the market excess return ERM according to Equation (1) based on
each funds specific lifetime. The bold vertical lines refer to the corresponding full-period factor alphas of SMB, HML and MOM. Funds are
first sorted into full-data funds and non-full data funds. Non-full data funds are then allocated to three subsamples based on the length of
fund return histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes. Panels A, B and C show the absolute
frequencies of factor alphas for LLT, MLT and SLT funds, respectively. Monthly factor alphas are reported in percent.

LLT funds
SMB factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
LLT funds
HML factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
LLT funds
MOM factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
MLT funds
SMB factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
MLT funds
HML factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
MLT funds
MOM factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
SLT funds
SMB factor alphas
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
SLT funds
HML factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
SLT funds
MOM factor alpha
F
r
e
q
u
e
n
c
y
-1.0 -0.5 0.0 0.5 1.0 1.5
0
1
0
0
2
0
0
3
0
0
Panel A: LLT funds
Panel B: MLT funds
Panel C: SLT funds
32
Panel A: All funds (MARC: 210.1) Panel B: FD funds (MARC: 54.6)


Panel C: LLT funds (MARC: 163.5) Panel D: MLT funds (MARC: 234.1)


Panel E: SLT funds (MARC: 357.9)

Figure 4: Scatter plots of fund ranks based on Jensen alphas and time period-adjusted Jensen alphas

This figure shows scatter plots of rank positions for all funds and for four fund subsamples. The evaluation period is fromJ anuary 1996 to
December 2009. The rank positions are based on the classic J ensen alpha (J A) and the time period-adjusted J A. Funds are first sorted into
full-data funds (FD funds) and non-full-data funds. Non-full-data funds are then allocated to three subsamples based on the length of fund
return histories. LLT (MLT, SLT) funds refer to funds with long (medium, short) lifetimes. Panel A presents the scatter plots of rank
positions with respect to all funds. Panels B to E present scatter plots of rank positions with respect to the FD, LLT, MLT and SLT fund
subsamples. MARC refers to the mean absolute rank change between the classic J A and the adjusted J A.
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