Relative Alpha

Abstract

The alpha within a factor model of fund performance could measure current outperformance over risk-adjusted returns; it could be used to identify funds which generate high future performance and thus determine fund flow; and it could be used to find persistence in alpha. We advocate a new measure to evaluate hedge funds - relative alpha. It links each hedge fund to a group of its peers in a straightforward, semi-parametric way. We do not require knowledge of the true factor structure. We show that relative alpha outperforms traditional, absolute alpha (e.g. based on Fung and Hsieh (2001)) along all three dimensions.