“Accidental Alpha”
Mar 1st, 2007 | Filed under: CAPM / Alpha TheoryWill hedge funds regress towards index-like products?
By: William Fung, London Business School & David Hsieh, Duke University
Published: January 2007
Will hedge funds succumb to the same fate as large chunks of the mutual fund industry: commoditization through ETFs and index funds? Merrill Lynch seemed to think so last October. And now, so do academics William Fung and David Hsieh. This research paper provides a “tool kit” to identify alternative beta, distinguish it from its hard-to-copy cousin, alternative alpha, and replicate it using basic trading rules that the authors say “capture the essence of hedge fund strategies”. These trading rules explain what they call an “accidental alpha” produced by traditional (linear) factor regressions.
The paper draws close parallels between mutual funds and hedge funds:
“There is a sense of deja vu among hedge fund investors that many hedge fund managers are beginning to resemble active managers in the mutual fund industry of the past—failing to deliver returns commensurate to the fees and expenses they imposed on investors. History tells us that over-priced active managers will be replaced by low-cost passive index-liked alternatives. Could the same process be taking place in the hedge fund industry?”
To continue reading this article please login (at the right) or click here to learn more about accessing our archives.
[…] All About Alpha on a research paper that identifies “primitive trading strategies” that helps distinguish alternative alpha from “accidental alpha.” […]
[…] Maybe I’m working too much. But the more I research alpha, the less I know how to define it. While Andrew Lo asks “Where does alpha come from?”, I’m now back at “What is alpha”?  For example, what might look like alpha over one timeframe is actually “exotic beta” when you shift the window of analysis only a few months. What looks like alpha vs. one benchmark may, of course, be beta when compared to a different benchmark. There’s ”active weight“, “active component“, “active share“, “absolute returns”, “reliance on public information“, “manager value-added” - even ”accidental alpha“. […]