The quest for alpha cuts both ways

• abnormalreturns
• August 30th, 2011

The quest for alpha cuts both ways.  Attempts to outperform the market are just as more likely to meet with failure then they are with success.  Therefore when a manager is able to put together a notable track record investors and the media sit up and pay attention.  Along with that often comes a flood of new investor money.

A raft of high profile investors have recently gone through some rough patches performance wise.  Some of these can be chalked up simply to bad market calls, like Bill Gross.  Others are far more worrisome.  John Paulson and Bruce Berkowitz have experienced poor performance coincident with them managing much larger sums than they had before.  This is a likely contributor to their results in 2011.

The challenge for investors is complicated by the fact that outperformance streaks are indicative of manager skill.  Investors therefore need to balance this signal against signs that a manager is set for a fall.  These include the previously mentioned issue of running too much money/too fast, style drift and a penchant to spend too much time talking to the media.

The financial media is always on the lookout for star managers, especially those that enjoy the limelight.  Investors should be wary whenever they see their portfolio manager spending more time on TV than they do at their desk.  No investor is bigger than the market.  Managers who think they have it all figured out are usually in line for a harsh lesson from Mr. Market.

Some links worth checking out on the topic:

The quest for alpha cuts both ways.  Just ask Bill Gross.  (Capital Spectator, MarketBeat)

Have Paulson and Berkowitz been brought down by running too much money?  (FT)

Bill Miller’s fund is now ranked last in its category over the past five years. (FT Alphaville)

Nobody’s perfect in the markets.  (Daily Ticker)

Robert Sinn, “Arrogance and overconfidence have no place in markets, just when you are most certain it is usually time to double-check your thesis.”  (Stock Sage)

[Earlier]  Barry Ritholtz fires Bruce Berkowitz.  (Big Picture)

[Earlier]  Skilled managers experience streaks of outperformance.  (SSRN)

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