A comment by a prominent academic has raised the issue of just how much alpha there is out there available to be exploited by the masses of hege funds. This is a crucial question. The main selling point of hedge funds is that they are the vehicle most able to generate alpha. If the amount of alpha is truly limited then it calls into question the fact that hedge funds have become a mainstream asset in institutional portfolios.

Jack Willoughby in Barron's writes that the comments by David A. Hsieh might be making some hedge fund advocates nervous. Unfortunately any discussion of alpha hinges on the exact definition of alpha. Disentangling the returns to certain risk factors from alpha is no easy task.

Alpha has become an overworked mantra in the financial-product sales community. Everyone knows what alpha means, but no one seems sure of how to identify it.

"We respect David's comments and we, like him, believe that alpha is finite, but so much depends upon how one defines alpha," says David Kabiller, founding principal at AQR Capital Management, a Greenwich, Conn., hedge fund that oversees $21 billion. "Definitions can be so ambiguous. For example, did he include merger/arb spreads as a potential source of alpha, or is it a risk premium? What about futures trading strategies? Or even convertible arbitrage?"

No one doubts the rush of capital into hedge funds is going to make generating alpha more difficult. The question for investors is, how much is too much? If hedge fund fees were truly based on the generation of well-defined alpha then there would be no problems. The problem arises when investors might end up paying for returns that do not truly represent skill.

Paul Kedrosky weighs in on this article (and topic) with a certain wit. Noting the comment by one hedge fund industry professional who makes a virtue out of the rush of capital into the industry.