Alpha vs. beta
Differentiate skill-based returns from market exposure and how funds target each.
Direct answer
Alpha is excess return from skill; beta is market-driven return. Hedge funds try to isolate alpha while managing beta exposure.
Walk through the structured answer
Define each component
Beta reflects systematic market risk; alpha is return unexplained by beta after adjusting for risk.
Measuring alpha
Use regression against a benchmark to separate beta; positive intercept indicates alpha after fees.
Portfolio construction
Long/short, factor hedging, and position sizing aim to capture alpha while neutralizing unwanted beta.
Use in interviews
Explain how your pitches deliver alpha (variant view) and how you’d manage beta with hedges or pair trades.
Pitfalls to avoid
- Confusing absolute and risk-adjusted returns.
- Ignoring factor exposures beyond broad market beta.
- Overstating alpha without a benchmark or time horizon.
Follow-up angles
- How would you hedge beta for this specific idea?
- What factors besides the market would you neutralize?
- Why can crowded trades erode alpha?
Keep drilling the set
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