One of the challenges for alpha is that it is difficult to prove. in fact, most alpha can be explained away. Consider the following three scenarios:
- If an investor beats the market with a portfolio of anything besides an index, observers argue that the investor took more risk or different risks. They will explain that higher returns are not from alpha, but from different factors or higher beta.
- If an investor beats the market by rotating sectors or adjusting duration, people will say, “That not alpha, that’s just beta rotation.”
- If an investor buys assets at the lows or sells at the highs, academics will explain that the resulting out performance is due to timing the market and exposure to systematic risk.
Generating alpha through any of the above activities can be explained away generally as beta rotation, but that does not negate the skill required and/or benefits gained. The much more important question is whether the actions and benefits can be consistently repeated to generate a material risk-adjusted return (net of expenses and taxes). Thus, finding that marginal return is much more difficult than labeling it as alpha or beta.