Alpha-centric investing described as a “seismic shift”

9 May 2008

We have always argued that actively-managed mutual funds are essentially a marketing package for two fundamentally different formations: a large deposit of beta and a vein of pure alpha.  Unable to travel either the peaks and valleys of beta or the undulating topography of pure alpha, mutual fund companies long ago found a neutral territory that seems to have satisfied investors worldwide for over 50 years.

Now the landscape is changing.  Or perhaps more accurately, investors are now expressing a desire to try their hand at portfolio construction using basic ingredients such as cash, beta, and alpha. 

This FT article (”Equity fund outflows bring need to adapt“) is a must read for anyone who thinks we’re nuts.  The newspaper describes the changes facing the asset management industry as nothing less than a “seismic shift”.  Kevin Parker, the head of Deutsche Bank’s $800 billion money management business tells the FT:

“On one side, you have exchange-traded funds and, on the other, you have [private equity firm] Blackstone and the hedge funds. It leaves firms like ours, traditional long-only buy-side firms, needing to make some very tough decisions.”

The FT also cites Jim McCaughan, CEO of Principal Financial Group as an advocate of alpha-centric thinking:

“Jim McCaughan, the chief executive of Principal Financial Group, believes the asset management industry has, in the past two to three years, undergone its biggest change since the 1960s…”

“Like Mr Parker and others, he sees the change as being investors’ shift to either “beta” in the form of indexed money or “alpha” in the form of absolute returns. A recent study by McKinsey estimated that corporate pension plans would, in the next five years, invest at least half the total of the $2,300bn they now have in equities into different strategies.”

Continues the FT:  

“Most analysts estimate mutual fund growth will be only about 2 per cent in coming years, meaning that fund firms must find new sources of revenue. Many are developing new and more lucrative high-margin products such as 130/30 funds – a modified long/short fund…”  

On its surface, the growth of 130/30 strategies seems to run counter to this trend.  After all, the whole purpose of this strategy is to combine more alpha with beta - not to separate alpha from beta.  But we suggest that the mere recognition of an alpha component and a beta component (often generalized as the “beta one” characteristic of these funds) makes 130/30 a step forward and worthy of the alpha-centric moniker. 

According to the FT, the seismic shift may change the landscape forever.  Just in case you read the STA report released last week (see posting) and believed that hedge funds are the only asset class with the capacity to shake the entire financial system, note that this article ominously concludes:

“The big outflows from managed equity funds could also have an impact on the stock market as more funds sell to meet redemptions.”  

The possibility that Q1 was only a tremor will surely keep Parker, McCaughan and other asset management CEOs up at night - and ready to stand in a secure doorway or take refuge in a bath tube when the “Big One” hits.

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One Response to “Alpha-centric investing described as a “seismic shift””

1. Russ Kamp - CEO, Invesco Quantitative Strategies Says:
   May 9th, 2008 at 7:14 am

   I agree that this is the direction that the plan sponsor community is taking, and as a provider of absolute return strategies for more than 17 years, I am certainly pleased to see this development. However, I am concerned that plan sponsors and their consultants are incapable of making two important decisions (alpha and beta providers) when they’ve had difficulty making one decision in the past. This may be a formula for disaster in terms of funding.

   BTW, 130/30 funds are not alternatives, as many unfortuantely have described.