Is It Possible to OD on Alpha?

Abstract

It is wellknown that combining multiple hedge fund alpha streams yields diversification benefits to the resultant portfolio. Additionally, crossing trades between different alpha streams reduces transaction costs: As the number of alpha streams increases, the relative turnover of the portfolio decreases with the crossing of more trades. However, Kakushadze and Liewargue that under reasonable assumptions, as the number of alphas increases, turnover does not decrease indefinitely; instead, the turnover approaches a nonvanishing limit related to the correlation structure of the portfolio’s alphas. The authors also point out that, more generally, computational simplifications can be employed when the number of alphas is large.