Alpha as a Net Zero Sum Game: How Serious a Constraint?
Dec 5th, 2006 | Filed under: CAPM / Alpha TheoryBy: Joanne M. Hill, Goldman Sachs
Published: Summer 2006, Journal of Portfolio Management
Although this article was published several months ago, Institutional Investor has recently posted it for free on its home page. If you’ve enjoyed reading some of the papers and articles in the Portable Alpha Hall of Fame, you’ll surely find this one interesting.
In it, Joanne Hill of Goldman Sachs unwittingly plugs this blog better than we ourselves possibly could:
“The interest in separating alpha and beta risk management shows that investors are becoming less willing to pay active manager fees for beta and are seeking index returns through low-fee fund products or tradable vehicles like exchange-traded funds (ETFs), index futures, and index swaps. The motivation for alpha-beta separation is a sound one because it aligns payment for investment skill with strategies focused on delivering relative or absolute returns.”
But more importantly, Hill argues that alpha is not actually a “zero-sum game”. Like Max Darnell of First Quadrant, she argues that the heterogeneity of investor utility functions mean that everyone’s a winner! (Well, if not everyone, at least more than half of all investors.)
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[…] Alpha as a Net Zero Sum Game: How Serious a Constraint? […]
[…] But how can this be?  Intuition suggests that more assets chasing the same inefficiency will eventually arbitrage- (”iron”) out that inefficiency. As Alexander Ineichen says in his new book, the market “learns” or “becomes immune” to the arbitrageur (although he does say that markets cannot be perfectly efficient). But according to Beltratti and Morana, market participants have heterogeneous utility functions (a notion also argued by Max Darnell, Joanne Hill, and William Sharpe): “The wide variety of real world investors, including noise traders and investors with heterogeneous time horizons and objectives, seems to provide plenty of opportunities for hedge funds managers to exploit: the limits of arbitrage do not seem to have been met yet.” […]
[…] Ineichen goes on to explain that the “fools” to which he refers are really just players behaving uneconomically.  Calling casinos the “second best business model ever”, he raises a point that is central to the argument that alpha actually exists. He says casino gambling losers aren’t really losers after all since they benefit from a “form of entertainment and sensation”. Regular readers will recognize this as being similar to the arguments put forth by Max Darnell and others to explain why alpha might be somewhat immortal. […]