Alpha or Not Alpha: The Case of the Hedge Fund Industry

Since the Markowitz mean-variance framework of 1952 and the subsequent discoveries of the CAPM and the APT, finance researchers have always strived to produce a reference performance measure adjusted for risk. With such a measure, any supplemental return would be denominated as “alpha”. But is this nectar real? How reliable is it when it comes to individual hedge funds and funds of hedge funds? Risk does not just measure variability. Volatility and correlations are certainly reductive. Investors are not necessarily lognormal. Leptokurtosis exists and market frictions prevail. On top of that, the existence of alpha is intimately related to its benchmark and the latter is particularly delicate in the hedge fund industry. This paper addresses the topic by reviewing the related research and challenging its results and the relevance of the existing pricing models when it comes to hedge funds and funds of hedge funds.