Sunday, October 3, 2010

Alphas, Betas, and Sales Pitch

On Friday I had lunch with a colleague that told me about a job interview when he used to be at Goldman Sachs for a position with on the sales team.

Being asked how good he was at sales the candidate - an Insead MBA student - said:

"I will sell your beta as if it were alpha."

If I was sure he came up with this answer on his own, I would have given him the job on the spot. Maybe I would prefer that he had told the truth and explained how he could sell high beta as a good market timing move, but I still fiound it a greant answer. For those of you that don't remember.know what is the difference between beta and alpha, here goes a (maybe not so) simple explanation.

In modern models returns are explained as a function of their exposure to underlying risk factors (like the stok market, liquidity, etc.). A fund that takes up lots of market-related risk will have a high "beta" relative to the movements of the stock market. Thus, any over-performance relative to market would simply be due to higher exposure to risk rather than a superior managerial skill (i.e. a high "alpha") possessed by the fund's manager. Alpha is the return over an above the expected given the fund's exposure to sources of risk.


  1. Hi Pedro, how would you transfer this concept from stocks to portfolio companies of an PE fund, in particular where no public data are available? Or is this concept focused more in funds based on stocks?

    Is this concept ("Treating beta like an alpha") feasible for discussions with portfolio managers who are going to buy stock from, e.g. Daimler?



  2. You can think that PE funds are also chasing alpha by trying to find the "next big thing".

    We shoud not forget that part of PE fund's higher returns have to to do with the risk (the "beta") and also with the high illiquidity of most of their investments/