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Step 3: Stock Pickers

working for the Guinness brewery in Dublin, Ireland to evaluate the quality of the brewery’s ingredients. The t-test can be used to determine if a series of historical returns is reliably superior – showing a t-statistic of 2 or higher – to a risk-equivalent benchmark. This can determine whether alpha (any return above the benchmark return) is due to luck or skill. In Figure 3-2, the t-test is applied to U.S. equity funds in six different style classifications over a 20-year period. Out of 237 mutual funds constructed with at least 90% U.S. equities, 99.0% of those fund managers did not have a statistically significant alpha, meaning any alpha they did have was due to luck, not skill. See the Step 5 Solutions section for a further explanation of the t-stat. Figure 3-2

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