Professor Harry Kat has been quoted extensively in the media and has become somewhat synonymous with hedge fund replication.  He has quickly developed a reputation for his irreverent views and his colourful commentary on the state of the hedge fund industry.  Love him or hate him, he’s got plenty of opinions to go around.  So “who better to write for a blog?”, we asked ourselves.  As a result, here is another edition of our occasional guest column we christened: “The Kat’s Meow”.  

The Kat’s Meow – February 16, 2007

Alpha is the part of an investor’s return that cannot be explained by the risks that he has been taking. It is the result of his specific investment skills. Of course, almost by definition, superior skills are scarce. However, that is not the impression one would get from the many magazines and conferences on the subject. From these, it appears that alpha is just about everywhere but the only one who is not getting any is you. The situation is not different from your high school days when everybody claimed to be having sex all the time, except you. The solution to this conundrum is simple, however: there is a lot less alpha out there than many people claim. In that respect alpha is again very similar to high school sex.

Although it may not seem like that, but true alpha generation is a dying art, as it is based on one simple concept: homework. Unfortunately, this is precisely one of the things most detested by modern man. Modern man wants to be out and about and flash his latest electronic gadgets in the business class lounge, not sit down quietly, doing his homework. Modern man therefore doesn’t collect information and form his own opinion. No, he skips the difficult part and instead of collecting information, he collects ready-made opinions. The media have figured this out and no longer purely provide information, but attach an opinion to it right away. Problem, however, is that most of these opinions are not worth the paper they are printed on, as they typically come from misinformed people who lack the background which thorough analysis requires. Building an investment strategy on opinions like these is guaranteed to produce no alpha whatsoever.

Many investors herald people like Warren Buffet and David Swensen as true heroes, as they have managed to produce truly remarkable returns over time. But what is their secret? The answer is simple: they do their homework. Warren Buffet collects information, spends months analysing it and when he’s satisfied he buys a serious chunk of the company in question and sits on it for as long as it takes for it’s true value to come out. Swensen’s story is very similar. He was one of the first to branch out in what we now call “alternative investments”. Not because it was fashionable and everybody was doing it. No, it was because he did his homework and concluded independently that it was the right thing to do. Since he was one of the first, he had access to some truly great managers and opportunities and consequently he did well.

Last year 24,000 people travelled to Omaha for Berkshire Hathaway’s annual shareholder’s meeting. Did these people expect Mr. Buffet to give them the secret recipe for success? They could have saved themselves the money for the fare, as the recipe is plain and simple: homework, homework and even more homework.

- HMK, February 12, 2007