Andy Lo has presented an interesting visual picture on the development of alpha through time which is consistent with the efficiency theory of markets through time. There may be a unique way to generate returns outside of market exposure but as more firm uses that technique it only becomes novel. The profits from the process are diminished. As the technique becomes popular, profits are further diminished and the unique value is eliminated.
There is less reason to pay a premium for these alpha generation services. Finally, the technique becomes well known or common and then represents a form of beta exposure. While I cannot always agree that this is a beta, a generalized technique cannot provide excess returns and should not receive a premium price for its generation. It is a beta in the sense that it is measurable and can be empirically tested. Think of the three factor Fama-French model.
This alpha popularization could be what happened to the January effect that used to exist in many equity markets. The value was diminished when everyone used it in their investment scheme. The effect started earlier or did not show up in a year. The small firm effect has been diminished as more managers switched to equities outside the S&P 500 and measure the impact.
Generating strong returns requires constant adaptation and development to stay ahead of the alpha popularization curve.
There is less reason to pay a premium for these alpha generation services. Finally, the technique becomes well known or common and then represents a form of beta exposure. While I cannot always agree that this is a beta, a generalized technique cannot provide excess returns and should not receive a premium price for its generation. It is a beta in the sense that it is measurable and can be empirically tested. Think of the three factor Fama-French model.
This alpha popularization could be what happened to the January effect that used to exist in many equity markets. The value was diminished when everyone used it in their investment scheme. The effect started earlier or did not show up in a year. The small firm effect has been diminished as more managers switched to equities outside the S&P 500 and measure the impact.
Generating strong returns requires constant adaptation and development to stay ahead of the alpha popularization curve.
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