The 80 billion Swedish krona Sjunde AP7-foden (“AP7”) public pension fund might as well be called the “Alpha-Pure” fund. Last year, the fund made a splash by re-organizing itself along alpha and beta lines and this week, one executive tells Thomson Investment News that the quest for “pure alpha” continues.
According to Thomson, AP7 CIO Richard Grottheim has just selected what he calls “pure alpha European equity managers” – this, after hiring two “pure alpha” domestic managers already this year. If these mandates pan out as expected, Grottheim says he will roll out the “pure alpha” strategy to Asia and emerging markets.
So what exactly is this “pure alpha” shtick anyway? More than an empty marketing promise, the term is used by AP7 to describe a form of unfunded alpha overlay that uses proceeds from shorts to fund long positions – kind of like the “30/30” portion of a 130/30 fund. Says Thomson:
“According to AP7’s new alpha/beta split, managers awarded a pure alpha brief are required to fund their own position by shorting their positions in stocks they see as less promising, while keeping their long positions on promising stock. At the same time the fund allocates a capped risk budget which the manager can use if needed.
The manager however is responsible for any cash need beyond the risk management budget and in return they are paid fees based on the size of the notional brief, risk portfolio and the out-performance.
This motivates managers to achieve pure alpha by long-shorting and protects the fund from hidden alpha at a reasonable cost, creating what Grottheim calls an ‘alpha centre’.” (Ed: “hidden alpha“?)
Regular readers (and Canucks) might recognize this as being similar to the strategy used by the $120 billion Canadian Pension Plan. According to its website:
“Our active overlay program places a layer of active selection over our passive portfolio of more than 2,600 public companies. In this structure, the CPP Investment Board retains the responsibility of managing the desired market risk exposure (beta), and our external partners are responsible for creating value by taking active positions on different securities (alpha) by selling less attractive stocks from our internal passive portfolio and buying more attractive stocks.”
According to another piece by Thomson (reporting from a European investing conference), Grottheim said that “the long-only manager that boasts a good research capability, strong track-record and reasonable fees can give hedge funds a run for their money.”
However, this does not – as Thomson suggests – mean that AP7 prefers long-only funds. Grottheim said that he is willing to hire a traditional long-only manager for a long/short overlay. In a statement that is sure to add fuel to the debate about whether long-only managers can be good at shorting, Grottheim told the audience:
“I think the capability to produce the alpha centres is in the tradition and the reach of the long only managers: they have the research capabilities, they rank stocks every day, they can take the investment process, put it together and create the product we want.”
Whether or not this is true, it raises an excellent point. At the end of the day, it’s not about “hedge funds” or “long-only” funds, it’s all about alpha.
By the way, who is the newest petro-dollar Sovereign Wealth Fund on the block (below)? Click here to find out.