Hedge Funds and Alpha

P

Preston Forbes

I've been looking around at different hedge funds to stick in a few 100k, and the selling point for one was that it "Generates alpha on a risk controlled basis"
....Sounds fancy but what the heck does it mean, I've asked a few broker friends I have and no one is sure.
 
Alpha is the extra return awarded to the investor for taking additional risk rather than accepting the market return.

Technically speaking, alpha is the intercept in the estimation model. It is expected to be equal to risk-free rate times (1 - beta).

In other words, they are doing what everyone else is doing, i.e. trying to beat the market, while controlling risk.
 
Quote from Preston Forbes:

I've been looking around at different hedge funds to stick in a few 100k, and the selling point for one was that it "Generates alpha on a risk controlled basis"
....Sounds fancy but what the heck does it mean, I've asked a few broker friends I have and no one is sure.
More...

Preston Forbes,,, 1 post ,, few 100k, doesn't know what alpha means,??? Hmmm, glad to meet you son my real name is Thurston Howell the 4th, but no one beleived it so call me Rennick. In your next post tell us about your yachts, Italien sports cars, hot women, just hurry up it's rude to hog the library computer.

...Rennick out
 
Perhaps we have different levels of schooling, please don't clog this message board with petty responses, this is a serious question.
Sure everyone knows what this term means, in marketing/sales terms, but the real answer to the buzzword is what i'm inquiring about.

More and more Hedge funds are glossing over their details with marketing hype, or selling themselves as something they are not, I invite any useful comments if you have them.

If you're any reader of the news, you would know that many many investors with millions more, are getting burned by bad hedge funds quite frequently, in the US and in Europe, so obviously many people arent asking enough questions.
 
Quote from Preston Forbes:


selling themselves as something they are not, I invite any useful comments if you have them.

.
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SWISH, that was a thunderdunk from beyond the free throw line.

...Rennick out
 
the term comes from the CAPM (Capital Asset Pricing Model), in short

r = alpha + beta * (r_m - r_f)

Where r is the fund's return, r_m is market return, r_f is risk-free deposit rate. Theory says that alpha=r_f, and its easy to increase your return by borrowing on margin which changes beta, or investing into more risky stocks. However, it is difficult to produce alpha and thats where the hedge fund pitch comes from. They will also claim that they have small or zero beta, meaning their return does not depend on where the market goes.

I am personally of the opinion that wherever such claim is justified by past performance data, you can shove them a 100K :cool:, should be fine unless they are conmen that is. Keep in mind that none of the top-quality funds are open to new investors. Plus, if you do not satisfy the high-net-worth individual requirements (like some here insinuate) and they are willing to look the other way, they most likely are con men.

But the real issue is whether you can figure out, if its not the SP500 that drives their return then what? Some have no original ideas any more than the Vanguard index fund, just doing the bread-and-butter hedgefund trades: the yield-curve carry, the yen/dollar carry, some short S&P puts, some short variance, but figuring out what exactly they do is probably hard.

K
 
Quote from William Rennick:

Preston Forbes,,, 1 post ,, few 100k, doesn't know what alpha means,???
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He didn't say he made all that money by trading. I'd bet more millionaires than not, don't know what alpha means either.

Stated in the simplest possible terms, assuming the reader has next to zero market experience:

Alpha just means outperforming the most relevant index.
If a one year old hedge fund specializes in S&P 500 companies, and over the past year the S&P 500 has risen by 6% and the fund is up by 7%, the fund has <b>successfully</b> generated alpha.
If the S&P is up 50% and the hedge fund is up 49%, the fund has <b>failed</b> to generate alpha.
 
Quote from kotika:

the term comes from the CAPM (Capital Asset Pricing Model), in short

r = alpha + beta * (r_m - r_f)

Where r is the fund's return, r_m is market return, r_f is risk-free deposit rate. Theory says that alpha=r_f, and its easy to increase your return by borrowing on margin which changes beta, or investing into more risky stocks. However, it is difficult to produce alpha and thats where the hedge fund pitch comes from. They will also claim that they have small or zero beta, meaning their return does not depend on where the market goes.

I am personally of the opinion that wherever such claim is justified by past performance data, you can shove them a 100K :cool:, should be fine unless they are conmen that is. Keep in mind that none of the top-quality funds are open to new investors. Plus, if you do not satisfy the high-net-worth individual requirements (like some here insinuate) and they are willing to look the other way, they most likely are con men.

But the real issue is whether you can figure out, if its not the SP500 that drives their return then what? Some have no original ideas any more than the Vanguard index fund, just doing the bread-and-butter hedgefund trades: the yield-curve carry, the yen/dollar carry, some short S&P puts, some short variance, but figuring out what exactly they do is probably hard.

K
More...

Good answer, though I would just like to add that the exact terminology is "Jensen's Alpha" (or Jensen's Measure if you prefer).
 
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