Factor Modeling and Benchmarking of Hedge Funds: Can Passive Investment in Hedge Fund Strategies Deliver?

Oct 19th, 2006 | Filed under: Academic Research, Alternative Beta & Hedge Fund Replication | By:
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By: Lars Jaeger & Christian Wagner, Partners Group
Published: November 7, 2005 

This article aims to give reference to this academic effort and provide a coherent discussion on the current status of ‘beta versus alpha’ controversy in the hedge fund industry. 

- Jaeger & Wagner 

We admit that we’ve been a little obsessed about the definition of alpha recently. It’s a phase. We’ll grow out of it. But we couldn’t resist the sheer number of Jaeger-isms in this article (i.e. colourful metaphors for alpha).  We even threw in a few of our own.

We have discussed the notion that alpha is simply beta that has not yet been commoditized, that hedge fund alpha is often exotic beta, and that systematic active/passive funds can fill the gap between true alpha and true beta.  This article sheds additional light on these issues. 

A Family Feud 

This extensive white paper was co-written by Lars Jaeger, a leading figure in the alternative investment research field (as many of you are aware). It’s a little long, but remarkably easy to follow. Jaeger and Wagner cover a number of key elements in the alpha/beta hedge fund debate. 

They essentially divide the world into two feuding families [our term, not Jaeger's]: those that say hedge fund alpha is just a difficult-to-execute beta and those that they call alpha protagonists (Americans, read: the Hatfields and the McCoys). They say the source of this dichotomy is a lack of general agreement on the definition of alpha in the long-only world, let alone in the hedge fund space. 

In attempting to mediate this feud, Jaeger and Wagner propose a sort of continuum from real alpha to alternative beta to traditional beta: 

More…

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  1. [...] All About Alpha reviews a paper that explores the relationship between alpha and hedge fund betas. [...]

  2. [...] Factor Modeling and Benchmarking of Hedge Funds: Can Passive Investment in Hedge Fund Strategies Deliver? [...]

  3. [...] International hedge fund celebrity, Lars Jaegar (see research) told Dailyii on Tuesday that hedge fund cloning could have a “dramatic effect” on the industry.  He went on to say ”This is going to turn the industry upside down”.  [...]

  4. [...] We find Ineichen’s Michaelangelo analogy is more complimentary than Jaegar and Wagner’s “garbage bag of a regression analysis”, more achievable than their â€œdark matter” and less scary-sounding than Mark Finn’s “swarm of bees“, [...]

  5. [...] posting on this paper) Archived in Alpha Beta Separation, Beta/ETFs, Hedge Funds | Trackback | del.icio.us | Top OfPage [...]

  6. [...] But although hedge funds have a unique governance model, they participate in the same battle for alpha as all other investors (hedge and long-only alike).  As a result, “hedge fund capacity” is really a misnomer. Â Lars Jaeger and Christian Wagner highlighted this fact in their interesting approach to calculating the theoretical capacity of the hedge fund industry.  For this reason, Brown and de Figueiredo also believe the capacity of the hedge fund industry “must be examined in a larger context”.  “The hedge fund ‘industry’ is not really an industry at all. Discussions about the future of the ‘hedge fund industry’ are misguided because we do not believe that hedge funds alone constitute an industry. Hedge funds, rather, represent a particular business model and governance structure within the broader active management industry.” [...]

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