How Significant is the CAPM Alpha?
(For those who are familiar with statistics, the T statistic (t-stat) is over three; it’s very significant. If you risk adjust, what you find is that on a risk-adjust basis you are adding closer to 2.5 percent per annum, because not only are you adding return, you’re reducing risk. You aren’t committing so much to the popular high fliers, the Krispy Kremes of the world, and then watching them implode. And so the statistical significance on a risk-adjust basis is off the charts — nearly a four T statistic. ) How consistent is this approach? It’s awfully consistent. During economic expansions, you add almost two percent a year. During recessions — when you most need those returns — you add three and a half percent. During bull markets you add 40 basis points. You don’t really add anything in bull markets, because they are driven more by psychology than by the underlying fundamental realities of the companies. And so during bull markets you keep pace. Which is good; it’s important. Dur
