Hedge Fund Alpha

Hedge Fund Alpha is determined by the manager’s skill. In order to determine this attribute, you need to separate the manager’s return from the standard return anyone could earn from the same basket of assets. The difference between the standard expected return and the manager’s return is known as the “alpha”. A manager’s alpha is determined by the hedge fund’s performance beyond or below the market rate. This accurately implies alpha can be positive or negative.

Alpha does not measure returns resulting as an impact of market movements alone. Alpha actually arises from two advantages, both of which are separated from the market: managerial skill and fund structure.

Hedge Fund Alpha: Skill Alpha

Alpha from skill arises purely from the selection of strategies and investments by the fund. Managers create or purchase digital systems which deliver inflows of information. Access to information in the modern age is fairly easy for any investor, and it is even easier for managers. A manager’s skill is not found solely in acquiring information.

The quality of a skilled manager is identifying relevant and useful information that can be used as the basis for generating investment returns. Separating quality and useless information that will not boost investment returns is essential. Rumors, lies, and baits are all frequently planted in the marketplace by opponents to deceive others for profit. Skilled managers often have industry or sector experience which allows them to separate actionable information from false or unrealistic statements.

Separating high quality evidence from low quality information is only the first step in acquiring skill alpha. Managers must successfully trade on the info acquired. The selection of individual assets and the timing of strategies also determine returns. Initiating trades too late or closing trades too early can result in substantial missed profits or even create losses.

Hedge Fund Alpha: Structural Alpha

A hedge fund’s structural alpha comes from advantages in government oversight and regulatory structure in comparison to alternative forms of investment. The lightly regulated status of hedge funds allows them to pursue assets and strategies off limits to index funds, exchange traded funds, and mutual funds. The returns gained from that structural advantage within the market contribute to structural alpha. Structural alpha results from their out performance of those assets.