Is the quest for alpha a religion? In some ways, it just might. This according to The Economist last week. Says the magazine (sorry, “newspaper”):
“The concept of alpha is a slightly metaphysical one and resembles the “God of the gaps” familiar to Victorians. Traditionally, people were inclined to attribute natural phenomena such as earthquakes and plagues to God; eventually they discovered plate tectonics and bacteria. The role of God was steadily diminished to that which people could not explain by other means.”
Separating the secular (beta) from the spiritual (alpha) has been the mantra not only of liberal democracies, but also of a new breed of investor. Hedge funds find themselves at the center of this metaphysical revolution, not because they simply aim to make “absolute returns”, but because they (claim to) have taken a vow of beta-celibacy. Continued The Economist:
“In a way, hedge funds, by virtue of their complex strategies, are one of the main perceived repositories of alpha left in the market (the average traditional fund underperforms the market, after fees).”
In an attempt to repent for their historical portfolio management sins, institutional investors such as pension funds aren’t just looking to hedge funds for short term gratification, but they are looking to them for something deeper – something to balance out the day to day ups and downs of beta.
Unlike many traditional religions, the alpha-centric religion is flourishing in both North America and in Europe. Citywire, a London-based online publication wrote in August:
“The latest trends in the European investment industry show that the separation of the fund market into an alpha world (active management) and a beta world (index funds and ETFs) is a reality.”
Meanwhile in the US, Wall Street & Technology wrote around the same time that:
“…the separation of alpha and beta is a critical growth driver of the alternative investment industry in general and hedge funds in particular.”
The magazine provided the following chart to illustrate why the preferences and objectives of institutional investors were so critical to the future of the hedge fund industry:
But a higher plane of being may prove somewhat elusive to some members of the monastic order of alpha seekers. Consultancy Celent observed just last week that:
“Alpha/beta bifurcation and greater levels of competition have made alpha generation an increasingly difficult proposition for hedge funds.”
Hedge funds might seem like a kind of fringe cult to many mainstream traditional investors. But while their unconventional approaches may sometimes seem unorthodox, their objectives are really no different than those of all other active investments – alpha.