For those deeply interested in the whole alpha-beta debate www.allaboutalpha.com is an excellent resource. One very interesting post in January (http://www.allaboutalpha.com/blog/2007/01/09/  a-financial-period-of-enlightenment) discusses work by Alexander Ineichen. It points out that effective market timing may look like beta in retrospect since, after-the-fact, the return for a given period will be explained by systematic market factors that were moving favorably. In the popular sense, however, this is really a form of alpha if the manager is able to adapt to a regime shift in a timely manner.

Clearly markets can never be perfectly efficient and there will always be some unsystematic returns available. In addition, not all managers seeking to exploit inefficiencies are equally adept. Thus the surge of investment in hedge funds in the past decade does not necessarily imply a proportional increase in EFFECTIVE exploitation of arbitrage opportunities. (This is closely related to Schachter’s point that the addition of less skilled managers pursuing a hedge fund strategy could actually lead to herding behavior and increase the available pool of alpha.)

The debate about the possibility of enhancing returns through active management is as old as the hills and as perennial as the grass. I remember it being actively debated at The Wharton School in the late 1960s. In the end it comes down to the point made by Merton Miller, namely “To beat the market you’ll have to invest serious bucks to dig up information no one else has yet.” The question is whether enhancing returns is getting harder as more and more investment managers deploy more and more funds with less and less constraints (such as long-only mandates) in an effort to take advantage of the hard won information they assemble. What we loosely call “the alpha pool” is not about to be drained. It just seems to me that what may have been easy pickings back in the late 1980s and early 1990s are unlikely to be so readily available going forward and investors would be wise to formulate their expectations accordingly.