This is the final dispatch from Alpha Male’s road trip to Institutional Investor’s Alpha Generation Forum in New York last week.
I’d be the first to admit alpha centric investing (portable alpha, active overlays, 1X0/X0 strategies, hedge funds, ETFs etc.) can be brutally boring sometimes.
But to their credit, the speakers at this event kept us all awake without need for intravenous caffeine drips or too many of those jam-filled conference pastries. I found three of the speakers to be particularly engaging â€“ mainly due to their enthusiasm about what they see as a fundamental shift toward alpha-centric investing: Mark Baumgartner, Executive Director of Morgan Stanley’s portable alpha group, Angelo Calvello, the newly-minted North American EVP at Man Investments, and Laurence Siegel, Research Director for the Investment Division of the Ford Foundation.
Baumgartner: Beware of Fast Food
Baumgartner describes himself as Morgan Stanley’s resident portable alpha evangelist. Like Alpha Male, Baumgartner was once a management consultant in the emerging technology space and believes there are many parallels between the adoption of portable alpha and the adoption of emerging technologies. In fact, one of Baumgartner’s research reports positions portable alpha in the context of Geoffrey Moore’s famous technology-adoption framework contained in the book Crossing the Chasm.
As VC readers will know, Moore’s book is about the difference between the attitudes and buying patterns of early adopters and those of the early majority. According to Baumgartner, crossing the chasm between these two market segments requires extensive market education. That’s where Baumgartner’s consulting background comes in handy.
To cross the portable alpha chasm, Baumgartner proposed a new risk regime to understand the challenges of portable alpha. His framework defines risk along two dimensions: perceived and actual.
He slots leverage, derivatives, and downside risk into the high perceived risk, low actual risk category (likening these risks to a shark attack â€“ dramatic, but highly unlikely).
Conversely, he says that alpha selection is perceived as being low risk, but is actually a process fraught with actual risk (similar to eating fast food â€“ seemingly innocuous, but more likely to kill you in the long run than a shark).
High Perceived Risk / Low Actual Risk (The Shark Attack)
Leverage, derivatives and downside risk are often considered 4-letters words by investors. The reality, says Baumgartner, is that these issues are not necessarily high risk. For example, leverage applied to low-correlated investments is not as bad as leverage applied to high-correlation investments. He goes on to argue that downside risk is usually mitigated, not increased, by the adoption of portable alpha strategies. Again, this is due to low-correlation between alpha sources and beta sources inherent in the strategy.
Low Perceived Risk / High Actual Risk (Fast Food)
Actual risk may reside in seemingly benign functions such as the selection of an appropriate alpha source. Picking the wrong alpha sources or not understanding the true volatility of beta sources can be far more dangerous than simply using leverage. In addition, not recognizing “embedded betas” can add significantly to risk without investors knowing it.
High Perceived Risk / High Actual Risk (Summiting Everest)
Baumgartner says portable alpha investors are correct in their assessment of these risks. He puts managing the system in this bucket and includes manager selection, due diligence and on-going monitoring. Like climbing Mount Everest, he says these activities are correctly perceived as being risky.
Baumgartner’s ideas are summed up in this article.
Angelo Calvello: No place to hide
Calvello, EVP of Man Investments, pulled no punches in his frank and outspoken commentary on the future of alpha-centric investing. With a Ph.D. in European Philosophy, and a firm grasp of self-deprecating humour, Calvello refers to himself as a Portable Alpha Idiot Savant.
He believes that the proliferation of passive hedge fund replication strategies will mean there will be fewer places to hide in the future for hedge fund managers. This, he argues, will actually cause prices for alpha to rise, not fall, as the supply of true alpha shrinks.
Calvello also believes that the current (alpha-centric) revolution will fundamentally impact many aspects of the asset management industry. Said Calvello:
This will impact the way we hire people, compliance, operationseven M&A in the asset management industry.
Laurence Siegel: 30% of drivers MUST be wrong
Laurence Siegel, Director of Research in the Investment Division of the Ford Foundation was co-author of one of the most popular papers we’ve posted here at AllAboutAlpha.com. As an investor, Siegel is able to offer a somewhat more skeptical view of the hullabaloo surrounding portable alpha.
Taking a page from William Sharpe’s playbook, Siegel discussed the zero-sum nature of alpha. However, he acknowledges the inherent requirement for all investors to believe they can actually produce positive alpha. The trick for the winning investors, he says with tongue in cheek, is to make sure the losing investors don’t realize their lunch is being eaten.
He likens this phenomenon to surveys that show 80% drivers consider their skills above average, which of course, is mathematically impossible.
Shark attacks, fast food, bad drivers and no place to hide? Who ever said investment conferences were a cure for insomnia?
– Alpha Male