“Operational Alpha”
Jun 20th, 2007 | Filed under: CAPM / Alpha Theory, Investment Management FeesAs the hedge fund industry matures and becomes more process-oriented, more and more hedge fund managers figure that if they can run their own back offices, why not run other peoples’ back offices? For example, Highbridge spun out Harmonic Fund Services in 2003 and Oak Hill spun out its back office into OpHedge in 2005. As various other managers enter this industry by spinning off their own administration functions, they bring with them a new language.
Nowhere is this more evident than in the recent announcement that hedge fund behemoth Citadel is launching an arm’s length hedge fund administrator, Citadel Solutions. Hedgeco.Net reports that Citadel caused a stir at SIFMA’s Annual “Technology Management Conference & Exhibit“ in New York on Tuesday with news of their new initiative (which is slated to go live July 1):
“John Buckley, President of Citadel Solutions LLC said: ‘Approval by the BMA (Bermuda Monetary Authority) is an important step in the further development of our activities. With the addition of Robin to our leadership team, we are well-positioned to become a leader in offshore fund administration. Robin and the Citadel Solutions Bermuda team build upon our unique service offering, the delivery of Operational Alpha to our clients.’”
Whoa. Hold the phone. “Operational Alpha“? At first blush, this term smacks of marketing schlock. But then we recalled a presentation given by a BGI executive to a gathering of AIMA (The Alternative Investment Management Association) last fall that could give credence to this claim. It turns out that the BGI executive, Ananth Madhavan, has since published his research in the form of an article last month called “Transaction Costs Analysis as a Source of Alpha“. While Madhavan’s paper pertains to transaction costs - not administration costs - the same lesson still applies: every dollar of expenses is a dollar is taken directly from alpha.
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[…] All About Alpha on the growing relevance of “operational alpha” in a increasingly complex trading world. […]
[…] It’s often cited that transaction costs erode any ‘edge’ hedge funds have over the market. This is a concern, because transaction costs shave both profits and add to losses, greatly harming the cumulative time effect that investing has. The key is to figure out the right mix. Allaboutalpha rightly points out that high managerial and performance fees can cripple a hedge funds ability to give investors returns. “Once largely overlooked, the impact of realized transaction costs on investment performance is now well recognized. Indeed, transaction costs can substantially reduce, or even eliminate, the notional returns to an investment strategy.” […]