Alpha is promised to no one. – Tadas Viskanta
I wrote that in regards to the underperformance of some high profile managers. Today another story in the WSJ about the performance problems of Jeff Vinik, former Magellan Fund manager (and owner of the Tampa Bay Lighting). The point being that managers cannot rely on any manager generating alpha over time.
In part these stories are puzzling, because in a world of ever more investors indexing it would seem that there should be more opportunities for managers to successfully pick stocks. A recent research paper from Nan Qin and Vijay Singal makes this very point. They show that greater indexing has led to less efficient stock prices. Inefficiency of course being the raw material for managers.
A couple of points that help offset this story of a greater supply of alpha. First is that at least in the US the absolute number of stocks traded on US exchanges has dropped dramatically over the past decade or so. From a USA Today article we see that from the year 2000 to 2012 the number of US listed companies has gone from 6,639 all the way down to 3,687. This drop has any number of implications one of which being a smaller pool in which managers can fish.
The second point is that over this time period the number of hedge funds, and the amount of money they manage, has increased dramatically over roughly this same time period. This means that managers are now stepping on each others toes to try and generate alpha. So even if the raw amount of potential alpha increased over this time period it is being spread over a much larger pool of managers. As Josh Brown at the Reformed Broker writes:
And now, all of this sameness and the mass-pursuit of market inefficiencies has led to an industry filled with intelligent players stifling each others abilities. Of course it did. If the world’s top fifty surfers all had to ride the same wave at the same time, how well could any of them do it? Jostling and elbowing each other for space and clear blue, whatever edge they originally paddled out with would be negated by simple physics.
The net result of all of this is that generating alpha is still a tricky business. Some ETF providers are trying to fudge the distinction between low cost, plain vanilla indexed ETFs which are now available at nearly zero cost and the many flavors of quasi-active index funds which have higher fees and track more narrow indices. Now matter how you slice the data the benefits of index-style investing are still visible in the data and increase with the amount of time you hold those funds.
That is not say there isn’t a free-rider problem with indexing. Index funds do nothing to help promote security pricing. However for the moment there seems to be no shortage of investors who are willing to step up with their dollars, and pay higher fees in the process, to try and capture some of this alpha. As the data shows alpha is an elusive beast for even the highest profile managers and is indeed promised to no one.