We develop a novel approach to separate alpha and beta under model misspecification. It comes

with formal tests to identify less misspecified models and sharpen the return decomposition of indi-

vidual funds. Our hedge fund analysis reveals that: (i) prominent models are as misspecified as the

CAPM, (ii) several factors (time-series momentum, variance, carry) capture alternative strategies

and lower performance in all investment categories, (iii) fund heterogeneity in alpha and beta is

large—an important result for fund selection and models of active management, (iv) performance

is increasingly similar to mutual funds, (v) fund valuation is sensitive to investor sophistication.