HF InterviewTechnical
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.
Step-by-step
Walk through the structured answer
1
Define each component
Beta reflects systematic market risk; alpha is return unexplained by beta after adjusting for risk.
2
Measuring alpha
Use regression against a benchmark to separate beta; positive intercept indicates alpha after fees.
3
Portfolio construction
Long/short, factor hedging, and position sizing aim to capture alpha while neutralizing unwanted beta.
4
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?
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