The Right Place for Alternative Betas in Hedge Fund Performance

Abstract

In recent months, concerns have been raised about the profitability prospects for hedge funds. This article argues that market participants' pessimistic view of the hedge fund industry's capacity to generate long-term returns is a direct result of their continued focus on alpha. It illustrates the importance of considering not only the exposure to the market (the traditional beta), but also other exposures (the alternative betas) to characterize alternative sources of hedge fund returns. It also revisits the capacity issue by distinguishing between market capacity and manager capacity. The results show that alternative betas are an important source of hedge fund returns that reduce the importance of alpha. The authors conclude that capacity issues do not significantly impact alpha by illustrating that alpha is generated by successful bets on numerous exposures rather than by exploiting market opportunities.