Hedge Funds: Is That Alpha For Real?

"The secret of acting," George Burns once explained, "is sincerity.

"If you can fake that, you've got it made."

The secret of a successful hedge fund is alpha – an investment return above and beyond the beta return produced by the market as a whole. Too bad you can't fake alpha.

Or maybe you can. Knowledge at Wharton reports on a study by Dean P. Foster of The Wharton School and H. Peyton Young of the Brookings Institution:

It's easy for an unscrupulous hedge fund manager to make himself look better than he is, as Foster and Young demonstrate in their paper. "We show, in particular, that managers can mimic exceptional performance records with high probability (and thereby earn large fees) without delivering exceptional performance."

You can download the research paper, "The Hedge Fund Game: Incentives, Excess Returns, and Piggy-Backing," here.