Redefining Hedge Fund Alpha and Risk Exposures after the Financial Crisis

26 Pages Posted: 12 Nov 2009 Last revised: 29 Nov 2009

See all articles by Raj Gupta

Raj Gupta

American College of Healthcare Trustees; American College of Healthcare Trustees

Hossein B. Kazemi

University of Massachusetts at Amherst - Isenberg School of Management

Edward Szado

Providence College

Date Written: November 10, 2009

Abstract

The hedge funds industry has evolved tremendously in recent years. According to the CASAM CISDM Industry Report, assets under management in hedge funds had grown from less than USD 50 billion at the end of 1990 to over USD 2.1 trillion at the end of 2007. However, assets managed by hedge funds have dropped significantly since then to less than USD 1.3 trillion at the end of June 2009. Since hedge funds have been marketed to investors as risk diversifiers in addition to being return enhancers, the actual “manager skill” or “value added” or “alpha” deserves careful examination at this time. In this article we examine the validity of the concept of “alpha”. We use both single factor (Jensen’s alpha) and multi-factor models to estimate alpha. We use three different indices with vastly differing construction processes and compositions. Unlike most previous studies, we choose specific factors for each strategy. Our results show that strategy specific factors had greater explanatory power but were insufficient to explain the wide variety of fund exposures. Multi-factor models were an improvement but nevertheless insufficient. We conclude that quantitative analysis is generally insufficient when it comes to measuring manager skill (alpha). Manager skill or “alpha” should be determined in a qualitative setting as well. Unfortunately, there is no measure that encompasses both quantitative and qualitative attributes although hedge fund ratings agencies have made some headway in this regard.

Keywords: hedge fund performance, alpha financial credit crisis

JEL Classification: G11, G21, G19, G29

Suggested Citation

Gupta, Raj and Kazemi, Hossein B. and Szado, Edward, Redefining Hedge Fund Alpha and Risk Exposures after the Financial Crisis (November 10, 2009). Available at SSRN: https://ssrn.com/abstract=1503432 or http://dx.doi.org/10.2139/ssrn.1503432

Raj Gupta (Contact Author)

American College of Healthcare Trustees ( email )

PO Box 1714
Houlton, ME 04730
United States
04730 (Fax)

HOME PAGE: http://www.facht.org

American College of Healthcare Trustees ( email )

PO Box 1714
Houlton, ME 04730
United States
04730 (Fax)

HOME PAGE: http://www.facht.org

Hossein B. Kazemi

University of Massachusetts at Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Edward Szado

Providence College ( email )

United States

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