Why The Search for Alpha is More Like Baseball Than Mining
Aug 10th, 2006 | Filed under: CAPM / Alpha TheoryBy: Alpha Male
The hedge fund lexicon seems to borrow heavily from the world of mining. Pundits talk about mining alpha, prospecting for alpha, and extracting alpha. They say that, like oil, there is a limited supply of alpha in world. In fact, like peak oil theorists, some are frightened that we are quickly exhausting the finite supply of alpha in the world – call them peak alpha theorists.
These Peak alpha theorists argue that structural inefficiencies that allow repeatable market-beating returns will soon be ironed out of financial markets. But those managers who are able to exploit such inefficiencies are taking them not from the ground, like oil or gold, but from other investors. We use the mining analogy because these other investors are such 
a diverse, faceless, and indefinable group. You never know exact who you took the alpha from – so you treat it as if it was simply lying there in the ground.
But this is where the resource extraction analogy falls down. Unlike oil, alpha was not left to us en masse by Mother Nature. There is no finite amount of alpha in the world ready for us to exploit. Alpha is situational, transitory, and relative. It has no physical dimensions and cannot be measured directly. As William Sharpe famously taught us, Alpha is a zero-sum game. For every investor who receives alpha – another investor looses it. Tris Lett, the elder statesman of the Canadian hedge fund industry, recently pointed out to me that such alpha losers might have less information, inferior skill, or simply have a different utility curve (witness the non-economic players in the commodity futures markets).
However, mining is not a zero-sum game. Every day, we all have more oil and gold. That’s why alpha is more like another well known zero-sum game: Major League Baseball.
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[…] Alpha Male agrees that, like oil, there will always be new sources of alpha to exploit. But the oil metaphor does have its weaknesses. In this post on why the search for alpha is more like baseball than drilling for oil, Alpha Male argues: “Unlike oil, alpha was not left to us en masse by Mother Nature. There is no finite amount of alpha in the world ready for us to exploit. Alpha is situational, transitory, and relative. It has no physical dimensions and cannot be measured directly.” […]
[…] Hill makes an argument that we have likened to interleague play in Major League Baseball. She says that certain segments of the market might generate net positive aggregate alpha on the backs of other segments of the market.  […]