Risk, the Pricing of Capital Assets, and the Evaluation of Investment Portfolios: Comment

In a classic article appearing in this Journal, Jensen presented empirical re­sults from which he concluded that mutual fund portfolios showed "inferior" performance over the 10-year period 1955-64 after the deduction of all oper­ating expenses, management fees, and brokerage commissions generated in trading activity.1 Jensen argued further that, as a group, the mutual funds performance was neutral when all operating expenses and brokerage commissions were added back to the fund returns; therefore, the resources spent by the funds in attempting to forecast security prices did not yield higher portfolio returns than those which could have been earned by randomly gen­erated portfolios. Finally, Jensen suggested that his evidence supported the "strong" form of the efficient market hypothesis—that is, the current prices of securities completely reflect the effects of all information concerning the securities, and efforts to acquire and analyze this information cannot pro­duce consistently superior results. This comment will demonstrate that Jensen's empirical analysis and conclusions were based on questionable methods of estimating the mutual fund rates of return and levels of systematic risk. More specifically, it will be shown that Jensen's methodology (1) understated the mutual fund rates of return (and therefore understated the measures of excess return), and (2) introduced unnecessary measurement error into the analysis by assum­ing that the measures of systematic risk for the mutual funds were station­ary over time. Read Full Text at http://www.geocities.com/castro_che2000/Norman.E.pdf