Alpha is shrinking, and it’s good news for investors. This idea may seem paradoxical. But alpha is really just the portion of a portfolio’s returns that cannot be explained by exposure to common risk factors (betas).
With the emergence of new betas, the unexplained portion (alpha) shrinks – alpha gets reclassified as beta. The rise of a group of risk factors we call hedge fund betas makes this transformation especially relevant today. Hedge fund betas are the common risk exposures shared by hedge fund managers pursuing similar strategies.
We believe these risk factors can capture not just the fundamental insights of hedge funds, but also a meaningful portion of their returns. Hedge fund betas are available for investment and can also be used to enhance portfolio construction and risk management.
Ultimately, we believe the rise of hedge fund betas will lead not only to the reclassification of alpha, but also to better-diversified portfolios with greater transparency, improved risk control, and – perhaps most importantly – higher net returns.