A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

LET’S LOOK AT THE RECORD
In Shakespeare’s 
Henry IV
, Part I, Glendower boasts to
Hotspur, “I can call spirits from the vasty deep.” “Why, so
can I, or so can any man,” says Hotspur, unimpressed. “But
will they come when you do call for them?” Anyone can

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theorize about how security markets work. CAPM is just
another theory. The really important question is: Does it
work?
Certainly many institutional investors have embraced the
beta concept. Beta is, after all, an academic creation. What
could be more staid? Simply created as a number that
describes a stock’s risk, it appears almost sterile in nature.
The closet chartists love it. Even if you don’t believe in beta,
you have to speak its language because, back on the nation’s
campuses, my colleagues and I have been producing a long
line of PhDs and MBAs who spout its terminology. They
now use beta as a method of evaluating a portfolio manager’s
performance. If the realized return is larger than that
predicted by the portfolio beta, the manager is said to have
produced a positive alpha. Lots of money in the market
sought out managers who could deliver the largest alpha.
But is beta a useful measure of risk? Is it true that high-
beta portfolios will provide larger long-term returns than
lower-beta ones, as the capital-asset pricing model suggests?
Does beta alone summarize a security’s total systematic risk,
or do we need to consider other factors as well? In short, does
beta really deserve an alpha? These are subjects of intense

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current debate among practitioners and academics.
In a study published in 1992, Eugene Fama and Kenneth
French divided all traded stocks into deciles according to their
beta measures over the 1963–90 period. Decile 1 contained
the 10 percent of all stocks that had the lowest betas; decile
10 contained the 10 percent that had the highest betas. The
remarkable result, shown in the chart below, is that there was
essentially no relationship between the return of these decile
portfolios and their beta measures. I found a similar result for
the relationship between return and beta for mutual funds.
There was no relationship between returns for stocks or
portfolios and their beta risk measures.