Even Cliff Asness believes in it. The boss of quantitative hedge fund AQR Capital Management, who studied under Eugene Fama at the University of Chicago, says he is still “respectfully scared” of the legend of efficient markets thinking when he asserts that alpha exists. “It does. But it’s rarer than people seem to think.”
The industry in Australia is in broad agreement. Michael Block, CIO at FuturePlus, says asset allocation decisions, not manager selection, are the most important decisions for multimanager investors, but are only given a fraction of a fund’s budget. Asset consultants should find these comments agreeable, but still commit much of their time to choosing funds managers to invest clients’ money. Why?
I can think of three reasons. (And I’m sure there are more.) First, alpha yields the ultimate investment thrill. It transforms managers from skilled practitioners into masters of the game, and provides them with the most compelling value proposition around. An exclusive and consistent source of positive, uncorrelated returns, it rightly entrances investors.
Second, alpha is a frustratingly rare commodity. It isn’t the knack required to successfully execute an investment strategy, but the unique ability of a manager to generate ideas that are different and superior to their competitors’. As a former teaching assistant to Fama, Asness would know that alpha produces the abnormal returns unexpected by equilibrium models – such as the capital asset pricing model that Fama co-developed with Kenneth French.
Third, and more irritatingly, alpha needs to be cultivated. (It’s special.) “You’d be amazed at how many great managers there are caught in the wrong business structure,” says Hugh Dougherty, head of manager research at Towers Watson. That’s why many launch boutiques to pursue investment and career goals. But they still need colleagues who can strengthen and balance their views.
True alpha is great – if you can get it. But in Australia alone, there isn’t enough to guide our $1.2 trillion in superannuation funds to outperformance – despite the large number of managers. This is why funds and asset gatekeepers scour the market for managers – not always in the search for alpha, but for good sets of hands to manage client money. Dougherty “very, very rarely” awards an investment mandate to a star investor alone. It comes down to teams.