Understanding what is Risk & Alpha?
Say you are a L/S equity HF PM managing a book. If you returned 10% (after) and say 6% of your returns are attributable to factor risk, is the 4% residual alpha risk free, driven by arbitraging away market mispricings? Or is that 4% residual actually driven by mainly idiosyncratic risk? Or is it a mixture of both?
We also assume that no other undiscovered common factor return exists within the residual.
I guess what I’m asking is, what are we exactly paying for “manager skill”?