Archive / Mutual Fund Distributors / Mutual Fund Scheme Performance

nism-series-va-jensens-alpha-fund-manager-performance[ MUTUAL FUND DISTRIBUTORS ]

Under the Capital Asset Pricing Model (CAPM), what does a positive Jensen's Alpha indicate regarding a mutual fund manager's performance?

[ A ]The scheme experienced a higher standard deviation than all debt funds in the country.

[ B ]The fund manager failed to beat the risk-free rate of return during the evaluation period.

[ C ]The scheme's Total Expense Ratio was higher than the maximum SEBI regulatory limit.

[ D ]The fund manager generated actual returns higher than the expected return dictated by the scheme's systematic risk (Beta), indicating value-add outperformance.[ CORRECT ]

Takeaway

Option D is correct: The fund manager generated actual returns higher than the expected return dictated by the scheme's systematic risk (Beta), indicating value-add outperformance.

Derivation

Jensen's Alpha measures the difference between a scheme's actual realized return and its expected return under CAPM given its portfolio Beta: Alpha = Actual Return - [Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)]. A positive Alpha indicates that the fund manager possessed superior security selection or market timing skills, delivering returns in excess of what was required for the systematic risk assumed. A negative Alpha suggests underperformance. This tests portfolio performance attribution. The common error is confusing Alpha with total unadjusted return.

Why the others fail

A — The scheme experienced a higher standard deviation than all debt funds in the country.

Standard deviation measures total volatility and is captured by the Sharpe Ratio, whereas Alpha measures excess return above CAPM expectation.

B — The fund manager failed to beat the risk-free rate of return during the evaluation period.

A positive Alpha means the manager outperformed the risk-adjusted benchmark hurdle, not failed to beat the risk-free rate.

C — The scheme's Total Expense Ratio was higher than the maximum SEBI regulatory limit.

Alpha is a portfolio performance attribution metric and has no relationship to regulatory expense ratio breaches.