Yes, Virginia. There is Hedge Fund Alpha.
Dec 22nd, 2006 | Filed under: CAPM / Alpha TheoryBefore we take a break for the Holidays, we wanted to share with you this touching piece of reader mail received this week. (American readers may note the uncanny resemblance to a famous letter to the editor appearing in the New York Sun over 100 years ago.)
Dear Alpha Male,
I am 8 years old. Some of my little friends say there is no hedge fund alpha. Papa says, ‘If you see it on AllAboutAlpha.com, it’s so.’ Please tell me the truth, is there hedge fund alpha?
- Virginia Jones
Virginia, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe unless they calculate ex post facto. They think that nothing can be which is not comprehensible by their algorithms. All factor models, Virginia, whether they be men’s or children’s, are inherently bias. In this great investment universe of ours, any portfolio is a mere insect, an ant, in its exposure when compared with the boundless financial market around it (as measured by its breadth, truth, knowledge, and its information ratio).
Yes, Virginia, there is hedge fund alpha. It exists as certainly as fear and greed exist, and you know that they abound and give to your portfolio its best opportunity for upside volatility. Alas! How dreary would be the world if there were no alpha! It would be as dreary as if there were no Virginias. There would be no poetry, no romance, no arbitrage to make tolerable this existence. We would have no enjoyment, except in beta and risk-free returns. The external light with which active management fills the world would be extinguished.
Not believe in hedge fund alpha! You might as well not believe in a “ten-bagger”. You might get your papa to hire men to watch all the prime brokerage accounts on Christmas eve to measure alpha, but even if you did not see alpha that night, what would that prove? Nobody sees alpha in such a short time frame, but that is not a sign that there is no alpha. The most real things in the world are those that neither Riskmetrics nor Beauchamp nor Pertrac can see in such a 
short time period. Did you ever see non-economic players consistently losing by taking the other side of that copper trade? Of course not, but that’s no proof that they are not out there. Nobody can conceive or imagine all the wonders that are unseen and unseeable in the world.
You tear apart your Jaguar and see what makes the noise inside, but there is a veil covering the market which not the newest Bloomberg terminal, nor even the united strength of all the strongest global macro managers that ever lived could tear apart. Only inefficient markets, patience, several dozen Ph.D.’s, and a definable ”edge” can push aside that curtain and view the asymmetrical beauty and glory beyond. Is it all real? Ah, Virginia, in all this world there is nothing else real and abiding.
No hedge fund alpha! Thank God it lives and lives forever! A thousand years from now, Virginia, nay, 10,000 years from now, it will continue to make glad the heart of investors.
- Happy Holidays to all. We’ll be back on the 28th.
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[...] This report also shows that hedge funds do better in December than in other months of the year (see related posting “Yes, Virginia, there is hedge fund alpha” from December 24th). [...]