Winners & Losers: It Takes All Kinds to Make the Alpha Game Work
| Jan 2nd, 2007 | Filed under: CAPM / Alpha Theory | By: Alpha Male |
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By: Tristram Lett, Integra Capital
Published: Winter 2006, Canadian Investment Review
The term “zero sum game” generally describes a somewhat negative predicament. For example, the field of psychology calls zero-sum games ”social traps” (MAD – mutually assured destruction, being one such trap). Generally speaking a zero-sum game (such as chess) has one winner and one loser – no ties.
As William Sharpe famously declared, alpha is also a zero sum game. If one group of investors manages to beat the average, then all other investors must lag the average by a commensurate amount in aggregate. Hedge fund protagonists and “peak alpha theorists” have latched onto this logic to support the argument that hedge funds do not provide value because they do not, in aggregate, produce alpha.
Tris Lett, author of this insightful commentary on our favorite topic, is a bona fide alpha hunter. But at the same time, he embraces the seemingly contradictory notion that alpha must be zero-sum in order for it to be valuable at all:
“…what makes (alpha) so special? If alpha were positive in aggregate, then you could invest passively in it. And, if you could invest passively in it, it would not be that special—and fees would be beta-like. In other words, alpha needs to be zero-sum or it’s not special.”
In fact, Lett takes direct aim at the peak alpha community for suggesting that asset inflows into hedge funds “dilute” alpha:
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