Active management: A portfolio management approach that aims to outperform a market rate or return, or a specific benchmark, by choosing investments that deviate from the market portfolio or benchmark.
Survivorship bias: Looking only at live funds and ignoring those that have liquidated or merged.
Median: The value below which 50% of the outcomes in a sample are found. Equivalently, 50% of the outcomes are found above the median.
Alpha: The rate of return on an investment in excess of a benchmark or the return predicted by a financial model. A more positive alpha implies greater outperformance, while a more negative alpha implies greater underperformance.
Surviving fund: A fund still available at the end of the sample period (June 2020).
Liquidated fund: A fund that sells all its assets and ceases to exist altogether.
Merged fund: A fund that ceases to exist as a separate entity because it is combined with other funds.
Fama/French Five-Factor Model: A financial model describing an equity security’s expected return in excess of the return on short-term bills as a linear function of five explanatory variables or “factors.” The factors are the market’s excess return over short-term bills (the market factor), the return difference between small and large stocks (the size factor), the return difference between value and growth stocks (the value factor), the return difference between high and low profitability stocks (the profitability factor), and the return difference between low and high asset-growth stocks (the investment factor).
Small and large stocks: Small stocks are those with a relatively low market capitalization, while large stocks are those with relatively large market capitalization.
Value and growth stocks: Value stocks are those with relatively low prices relative to book value, while growth stocks are those with relatively high prices relative to book value.
Profitability: A company’s operating income before depreciation and amortization minus interest expense scaled by book equity.
Investment or asset growth: A company’s annual percentage change in total book assets.
Probability distribution: A tabulation or graphing of the frequency of different outcomes in a sample.
Percentile: The value below which a given percentage of outcomes in a sample are found. For example, the 5th percentile is the value below which 5% of the outcomes are found; equivalently, 95% of the outcomes are found above the 5th percentile.
Tails of a probability distribution: The extreme outcomes in a sample that occur with a relatively low frequency.
t-Statistic: A measure of the statistical reliability of an estimate. It is defined as the value of the estimate divided by the standard error of the estimate, where the standard error is a measure of the imprecision in the estimate. For example, a value more positive than 2 or more negative than -2 indicates that the estimate is more than two standard errors away from zero.