Alpha/Beta Separation & Integration is #3 Trend for 2007: New Watson Wyatt Report

26 Jan 2007

“2007 Global Pension Assets Study”
By: Watson Wyatt
Published: January 24, 2007

“Alpha/Beta Separation” isn’t just another pretty face.  This year it’s listed third on Watson Wyatt’s list of the “Six Faces of Change” for pension investing.  The “six faces” include:

  1. Liability-driven investing
  2. Absolute return strategies / alternative assets
  3. Alpha / beta separation & integration
  4. Beta prime innovation / capturing systematic “alpha” in an index form
  5. Reducing defined benefits plans’ risk budgets
  6. Pension funds’ increasing power to influence pricing & product design

Number four is also noteworthy. Watson Wyatt quite rightly places “alpha” in quotations since “systematic alpha” is arguably an oxymoron.  The firm includes cap-weightings (a la Fama & French), and “wealth-weighted indices” in this category.  We guess that Rob Arnott’s S&P-beating “fundamental indexation” would also fall into this category.  But you could also include “hedge fund replication” here too, since it also aims to systematize what we commonly assume is “un-systematizable”.  Taken together, this particular “face of change” is the only one (of the six) that Watson Wyatt says is destined to grow from “tiny” to “big” (its largest category) in the future.

Nowhere in this report does Watson Wyatt utter the over-used term “Portable Alpha“, and we are thankful for that. Overall, we would describe these changes as “alpha-centric investing” since porting is really just one of many things that can be done when alpha is identified, manipulated, and “replicated” (exotic beta).  As regular readers will know, these ideas (in both their institutional and retail forms) are the focus and passion of

Watson Wyatt also echoes our view on the parallels between e-business and hedge funds when it predicts that emerging financial “technology” will drive change at an unprecedented level in 2007.  Roger Urwin, global head of investment consulting at Watson Wyatt (and coincidentally, a speaker at an upcoming Hedge Fund Replication conference in London) says:

“Four of these changes concern investment strategy of which the most prominent is LDI. The impact of technology, particularly with respect to knowledge on finance theory and best practice, is making the clock-speed of change tick substantially quicker than in any prior period in the industry.”

So adjust your watches folks.  This faster “clock-speed” is sure to make 2007 a very interesting year in the asset management business.

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