Whatever happened to alpha - How much beta is in the alpha?

June 18th, 2018

It would be great to have actual quality information on the alpha generated by funds, but in order to do that, you need to understand how much beta exposure they have.

Well, when you look at the data, in aggregate, hedge funds look like (moderately) higher Sharpe ratio stocks.

Now, some of this makes sense just from the perspective that alpha is a zero sum game, so any aggregate is going to wash a lot of the alpha out, leaving you with an index that look like the asset weighted portfolio mix of a manager.

But, again, by looking across hedge fund strategies, it’s possible to see that not only do many strategies seem to be proving a lot of beta with their alpha, but over time more and more of those returns are being dominated by beta.

Which got us thinking. US equities might be a reasonable beta benchmark for a long-short investor, but what about someone playing their trade in global macro?

There are as many beta portfolios as there are schools of investing, but for expediency we constructed an “All Beta” portfolio which simply put equal weights on every equity, bonds, commodity and FX market for which we have data.

For US macro funds, a simple beta portfolio is just a diversified mix of all the equity, rates, commodities and currencies they can invest in.

This is what that All Beta portfolio looks like, in excess returns space, when targeted to 15% annual volatility.

Here’s how that portfolio relates to the returns of macro funds, when viewed against a smoothed version of the strategies average Sharpe ratio.

Ok, so we know the answer at least to that question (how much beta in the alpha) is…not zero.

Whether it’s 25% (for an individual firm) or 75% (for the industry aggregate), it’s clear that yes, investors are getting a lot of beta along with their alpha.

In which case, the question becomes, what else is driving that blue line?

Which we will get to, another time…

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