Whither alpha? Alexander Campbell, in fine form, officiates at a debate between David Rowe and Barry Schachter. All of them, refreshingly, reject the idea that there’s some limited supply of alpha, and that as the number of hedge funds and others chasing it increases, there will be less to go round for the average hedge fund manager.
Campbell’s blog entry is a fine introduction to the debate. My view is that alpha comes from global imbalances — things like currency pegs which cause distortions in the market. Right now, there are more global imbalances than ever before, which implies to me that there should be more alpha than ever before.
Specifically, I think there’s a big delta in the financial markets right now. (I think delta is the right word…) You have the hedge funds and private equity types at one end, who are all about making money and generating alpha. And then you have the world’s governments at the other end, who are all about accumulating reserves and who really don’t seem to mind very much if they underperform the market. So long as this state of affairs continues, both can be very happy.
(One extreme example of this is Russia, where the government sold off its patrimony at fire-sale prices to ultracapitalist investors. Lots of alpha for the investors there — and the Russian people are the losers.)
More generally, there seems to be more money chasing low-risk fixed-income investments now than at any point in history — this is why private equity is making so much money by issuing vast amounts of cheap debt. There are lots of investors who want risk-free debt, and lots of hedge funds, investment banks, and the like who can make money off the fact that issuing debt can generate higher returns for equity investors.
So count me in with the people who think there’s likely to be more than enough alpha to go round for the foreseeable future. That said, of course, there will always be a lot of hedge fund managers who think they’re better than they actually are, and who end up just giving money away to the managers who really generate alpha.
Felix — to make your imbalance story work i think you need a couple of additional steps, since private equity firms don’t issue risk free debt that really appeals directly to most official institutions.
I think those steps are:
a) institutions who don’t worry about currency risk are putting lots of euros and dollars on deposit in the world’s banks, allowing the banks to take on a bit of credit risk (especially with relatively flat yield curves making it hard to simply borrow short and lend long)
b) institutions that don’t worry about currency risk are buying lots of relatively safe treasuries and agencies, driving down yields on those instruments and providing the former holders of those instruments (pension funds, insurance cos) with cash that they invest in somewhat riskier assets as part of a more general search for yield.
incidentally, you don’t seem to be spending all that much time at the beach, and i would be interested in your take on the latest data on the mortgage market and the markets reaction to it — in the past, you have argued to trust markets not economists and today the data (foreclosures, late payments, etc from q4) seemed to scare the market a bit … are you worried you have got goaded by a few prophets of doom and gloom into a position that looks a bit more sanguine than justified by the data? or are you still confident subprime woes will be confined to those in the biz of making those loans and repackaging them, b/c the market has dried up, with losses in the secondary market concentrated in the equity and perhaps mezz tranches of CDOS created of subprime mortgages?