The benefits, costs and risks of 130/30, portable alpha, hedge funds and other emerging investment techniques are now quite clear to those immersed in the hedge fund and asset management community. As we debate abstract ideas such as market inefficiencies, it’s easy to become frustrated with the pace of adoption. But the fact remains that communicating these ideas to a broader audience of investment committees and advisers remains a critical step in the gradual acceptance of alpha-centric investment techniques.
This interesting report reminds us of the enormity of this communication and education task. Consulting and advisory firm Strategic Investment Group sponsors a number of roundtable sessions involving institutional investors each year to discuss topical issues in the industry. They call this initiative the “National Strategic Investment Dialogue” (NSID) and its output is summarized in a report at the end of each year. While these annual reports are not available to the general public, NSID has allowed us to provide you the 2006 edition in full here.
The 2006 Year in Review report finds that institutional investors are “…afloat on a sea of ambiguity”…
“Not all parties are fluent in this new language. Further difficulties arise as new investment strategies are viewed through the prism of the traditional investment vocabulary or when different parties interpret the same terms in a different manner; these are disconnections that can have far-reaching consequences. As one participant noted, ‘we are afloat on a sea of ambiguity.’ Polling showed that the NSID participants believed a number of popular terms are misunderstood or over-used.”
And here’s a map of the Sea of Ambiguity..
Keep in mind that the chart above lists only the “most over-used and misunderstood” terms. In other words, it’s quite possible that poll participants may believe that most or all of these terms are over-used or misunderstood. (Ed: Ten bucks says 130/30 would have been a contender had it been included.)
We’re not that surprised to see hedge funds, portable alpha and absolute return on the list. After all, many hedge funds don’t hedge anymore, many portable alpha strategies don’t actually port alpha anymore, and absolute returns has always been an aspiration, not an investment strategy. But it seems that leverage is also poorly defined concept. In fact, more than half of respondents said their investment committees had a problem with leverage even if it could be shown to increase returns without necessarily increasing volatility.
While fear of the unknown may have been behind some of this reluctance, some participants in the study expressed fear that it was actually their investment staffs that might not fully understand the implications of leverage.
The study finds portable alpha is also the source of much confusion. In fact, respondents felt that “portable alpha” was just one part of a much larger investment paradigm (that we refer to here as “alpha-centric” for lack of better term).
The report suggests that Modern Portfolio Theory’s need to divide the world into asset classes is behind much of this “semantic confusion”. In an apparent affirmation of William Sharpe’s contention that asset allocation studies are “inferior” (see related posting), over half of participants said that the very concept of a “policy portfolio” needed to be either revised or reinvented…
There is a lot more to the report on the adoption of hedge funds, portable alpha etc. So it’s worth a read. If your job is to educate clients, you’ll find it really hits home. And if you are an institutional investor exploring alpha-centric strategies, you may find comfort in the fact that others are equally as confused about the promise and peril of the “new investment paradigm”.
In the end, thankfully, there seems to be quite a bit of agreement that alpha-centric investing is here to stay…