Conditional Performance Evaluation, Revisited

One of the most difficult challenges for investors is to assess whether a fund's performance arises from a manager's skill or is simply the product of chance. Track records by themselves are typically too short to distinguish skill from chance. Moreover, what shows up as alpha may instead be an artifact of a misspecified benchmark. The consequences of poor performance evaluation are significant. Investment managers are needlessly fired, and perhaps more often, unjustifiably hired. And the transaction costs associated with this turnover substantially and unnecessarily dilute investor savings.