Description:
Standard Fama-French-Carhart models are widely used by academics to assess risk-adjusted fund performance versus market, size, style and momentum factors. However, it fails to reflect the industry standard, following which the performance of money managers is commonly evaluated relative to a corresponding benchmark and the peer group. In this paper, we introduce a new approach that augments the Carhart model and enables investors to identify the funds that outbid both the benchmark and the peer group. In addition, it allows discovering more certain winners by eliminating the under(out)performance of funds driven by the bias in the FFC factor construction. The application of our model is illustrated on Large Cap Value US active equity mutual funds using contingency tables. The performance and persistence in performance are assessed by comparing the novel and the standard Carhart models. We find that winners suggested by our approach earn more than twice as much as winners from the Carhart model (49bps vs 20bps annually) and show persistence in performance 36 months ahead. The results are robust to different specifications of contingency tables