AllAboutAlpha Exclusive – On Tuesday evening, AllAboutAlpha’s Editor-in-Chief Alpha Male co-moderated a dinner discussion in an un-named US city featuring “The Hsieh” himself. Dinner guests included investment leaders from several large pension plans and was hosted by the Canadian Chapter of the Alternative Investment Management Association (AIMA) and portable alpha pioneer, Integra Capital.
As you may recall, Duke professor David Hsieh caused a stir in the hedge fund community last spring when he suggested that the overall amount of alpha available in the hedge fund industry was only around US$30 billion (posting). Subsequent commentators have suggested that he may not be far off since $30b represents about 3% of alpha on the $1.1 trillion industry – and that 3% “free lunch” sits adequately well with many academics.
When asked to clarify his remarks at the dinner discussion, Hsieh said that the original comment was made off-the-cuff in response to a fellow panelist at the CFA Institute’s Hedge Fund Conference. He told the dinner guests that he was surprised the remark had generated such a stir.
However, Hsieh refused to provide a new estimate of the capacity of the hedge fund industry (perhaps for fear of generating more controversy). But he did say that the theoretical maximum size of the hedge fund industry was a moving target since some market inefficiencies were constantly being ironed out while others emerged to take their place. These emerging inefficiencies arise, says Hsieh, from new and often poorly understood markets. He offered up mortgage-backed securities as an example.
Participants asked Hsieh when exactly these new inefficiencies would arise. Pointing to the exogenous nature of such “bump-ups” in alpha potential, Hsieh said it was impossible to know exactly when or where they would develop. When pressed on this point, Hsieh agreed that while the exact location and amount of new alpha sources was unpredictable, new inefficiencies would likely always emerge to replace ones that had been ironed out.
In response to a question regarding the alpha potential of new managers, Hsieh was not overly optimistic about the newest vintages of hedge fund managers. Admitting to an “academic bias” in his answer, he suggested that the highest-returning managers would already have self-selected to enter the hedge fund industry early on in its evolution. Therefore, new entrants should not be any better than more experienced managers – and in fact they should theoretically be worse.
One participant in the discussion asked Hsieh if true alpha would eventually be explained away by simply finding new factors (called “exotic” or “hedge fund” betas). Hsieh responded that alpha and beta exist on a continuum and that the terms need not be dichotomous or mutually exclusive. Some factors were simply more alpha-like (hard to find, complex to replicate etc.) and some were more beta-like (liquid, easy to replicate).
An obvious crowd favorite, Hsieh was very engaging as he held court with this very sophisticated audience. He concluded by addressing questions about his recent factor research findings in advance of his formal remarks to a plenary session of the aforementioned institutional hedge fund conference. Stay tuned for more on that later in the week.
– Alpha Male