Alpha Beta Hot Potata

OK, time to deal a little more with the Alpha Beta phenomenon and money management.

Beta is essentially the perfomance of an index. Lots of it available cheaply through ETF's, index funds, etc. Think of Beta as a commodity.

Alpha is outperformance of an index - and it's the stock in trade of hedge funds. Alpha is costly - "2+20" is the standard. A 2% management fee plus 20% of gains gets paid to the fund manager. And in a FOF (fund of funds) structure you can add in an extra management fee.

Well, the question for 2006 (at least through August 31) has been "where's the alpha?". Through that date (after fees) hedge funds returned an average of 4.2%, according to some sources, whereas the S&P returned 5.8% for that period.

So, why are investors (in apparently ever increasing amounts) going after the elusive alpha?

One theory is that future likely composite returns from bonds and equities look to be maybe 6%. However, when investors like pension funds assess liabilities they need to do better than 6%. Hence, little choice but to gamble on getting the alpha.

I'd be interested in any other theories or any dissentions.