Absentee Alpha

The quest for alpha — above-market returns — is the essence of the hedge fund industry, so this factoid from the weekend Barron’s is illuminating:

David A. Hsieh, (pronounced Shay), a finance professor at the Fuqua School of Business at Duke University, estimates that the $1 trillion hedge-fund industry is chasing a mere $30 billion in alpha per year. That’s precious little to support the hefty fee-generating machinery, ostensibly developed to scoop up excess return.

“My comment…was that if there’s $30 billion of market inefficiency, in a world of $30 trillion of equities and
bonds, then we have about 0.1% inefficiency — less than the typical bid-ask spread!”

And what do hedgies think about this? They entertainingly deny, deny, deny, of course:

“Academics often have a more textbook approach than experienced practitioners and those estimates make for good cocktail talk,” says Alain DeCoster, founder of ABS Investment Management, a fund of funds based in Greenwich, Conn.

“If what he said were true, then investors would have been leaving hedge funds, not piling in, as they have for the last five years. Investors go to hedge funds in search of better risk management and greater talent.”

Right, because we all know that investors are entirely rational in the short run and never fall for bandwagon effects or the next hot thing.


  1. Hold on….great post.
    $30bil, that’s gotta be an underestimate. Theoretically…if betas significantly fluctuate, wouldn’t one expect alphas to follow?
    0.1% is too stable…compared to how much market normality fluctuates, I wouldn’t expect market abnormality to be so normal.
    At any rate, alpha’s elastic. Inefficiency comes in waves and, $30 billion can’t be a static number – it’s going to significantly expand and contract.

  2. kmpbj@hmt.com says:

    What are bandwagon effects? Does that mean people just tend to get on the bandwagon or that the fact that people tend to get on the bandwagon has effects? Does every human behavior have to be explained by a social science or evopsych mechanism?

  3. Hmmm, did you have a psych/socsci professor irritate you earlier in life? Call it what you will — bandwagon, momentum, faddishness … whatever — but there is more to the recent collective ardor for hedge funds than coincidence and/or raging rationality.
    Saying so, however, is not the same thing as saying that every “every human behavior [has] to be explained by a social science or evopsych mechanism”.
    The preceding said, I’ll turn it around: In the face of ample and growing evidence (such as the above) that many hedge fund investors are in denial about likely returns, give me an entirely non-behavioral explanation of the phenomenon. I’d happily hear it.

  4. Brent Buckner says:

    I suspect Dr. Hsieh didn’t include alpha now available from shorting what he would of necessity deem overvalued stocks of hedge fund managers :-)
    It’s a dynamic world.

  5. Dan Arlandson says:

    $30b is likely a huge underestimate. Prop desks alone are generating in excess of $30b in alpha a year.

  6. The mere existence of a $1 trillion hedge fund industry provides pretty compelling evidence that one or both of the following is true:
    1. There a lot of alpha out there to capture, or
    2. Institutional investors who provide the bulk of that $1 trillion to hedge funds on 2/20 terms are irrational.
    If #2 is true, it doesn’t seem possible that #1 isn’t. Either was, there’s a lot of alpha out there.