Both are available within the hedge fund universe, but very distinct in nature, philosophy and objectives. One is a derivative of traditional asset management, but offered within a risk-mitigated framework. The other is greatly misunderstood; even by seasoned hedge fund industry practitioners, and by virtue of the fact that it consist only a small subset of the overall hedge fund universe.
Failing to distinguish between the two ultimately leads to costly disappointment and impairment of the vested fiduciary responsibility.
Alpha-seeking managers eventually underperform. They systematically fail to protect capital in market dislocations. Alpha is not a stable and regularly observable phenomenon. Alpha is not necessarily earned in the period in which it is measured and that true skill may be demonstrated in the period of idea generation, i.e. before portfolio implementation, rather than in that securitys subsequent outperformance.
A managers ability to add Alpha is dependent on external forces that are beyond his control, such as the emotions of other investors. After all, the market, not the manager, ultimately determines prices.
The propensity of absolute return is increased as capital isdynamicallyallocated to ideas that are currently rewarded by the collective perception of reality; i.e. the Market. However, it also dwells on thedisciplineof retrieving back the capital when the market is no longer receptive to the idea. This is otherwise known as Active Risk Management.
Discipline is avoiding or suppressing two particular behavioral biases: Overconfidence and the Disposition Effect.
An active and disciplined risk management process suppresses the behavioral biases. The focus on Alpha, while relying on hedging and other risk mitigation tools, effectively subsidizes the destructive behavioral biases.
As well, absolute return strategies tend to embed long Gamma components in the portfolio; but most importantly, they consistently avoid both explicit and implicit short Gamma exposures.
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