Does alpha really matter? Evidence from mutual fund incubation, termination and manager change

The assumption that market participants risk-adjust when measuring performance is common in finance. However, empirical research has shown that raw returns play an important role in retail investment decisions. As financially sophisticated investors, fund management companies understand the importance of risk-adjustment, but because their profits depend on retail investment, raw returns may influence company strategy. Whether or not alpha is important in management company decisions is an open question. This paper addresses the question by exploring the role of alpha in key decisions: the incubation and termination of funds, and the promotion and demotion of fund managers. The major finding is that alpha is not important to external decisions, those highly visible to investors, but is important for internal decisions. This paper also documents the existence of a strategy for enhancing return histories called incubation. A previously undocumented form of survival bias due to incubation is identified.