One of the surprising thing in writing this blog is that certain stories seem to just hang around. Last year(!) we had a post “Frenetic hunt for alpha” that documented the lengths institutional investors were going to try and generate extraordinary returns. Apparently the trend continues apace.
Scott Patterson in the Wall Street Journal revisits the portable alpha story. Portable alpha strategies are all the rage among both fund managers and institutional investors alike. In short what is portable alpha:
The idea behind portable alpha is simple, though how it works can be complicated. Instead of stashing money in a mutual fund to invest in the market, investors use a derivative that tracks an index such as the Standard & Poor’s 500-stock index. These financial contracts give them cheap exposure to the broad market, freeing up extra cash to put into hedge funds and other investments, providing the “alpha” part of the strategy.
Portable alpha in theory is a sound strategy. Investors should seek out alpha in whatever asset class or strategy that is available to them. The challenge is of course is successfully and consistently generating alpha. As we have written the generation of alpha is “neither cheap nor easy.” There is rightfully a great deal of skepticism that there is enough alpha out there to be “ported” over to other asset classes.
For instance, Melanie Feisst in the Telegraph cites a KPMG report that “an oversupply of mediocre hedge funds in Europe has dampened both industry performance and investor sentiment.” The point being that the flood of capital into hedge funds has in some cases affected the efficacy of some hedge fund strategies. Hedge funds are being forced to evolve or die. What it means for the hedge fund investor is likely disappointment.
This disappointment in hedge fund returns was driven home in a post by the fine folks at CXO Advisory Group. In it they summarize an article on the performance of hedge fund of funds, which are a common vehicle for investors in hedge funds. The research finds that fund of funds have generally demonstrated lower excess returns over time and the risk taken has increased. There are demonstrable problems with the fund of fund structure, mainly the layering of fees of fees. These investors are supposed to be the experts in hedge funds and if they are finding it increasingly difficult to pick successful hedge funds, then it should give some pause that they can do the same.
None of this precludes the possibility that there are hedge fund managers out there that genuinely have the ability to generate alpha. The problem is that the overwhelming flood of capital into what had been a cottage industry has changed the dynamics completely. Managers who once ran cozy operations are now managing, in some cases, tens of billions in assets. Start-up funds with little in the way of track records can now garner hundreds of millions to launch.
Portable alpha is simply another manifestation of this trend. It is hard to believe that the institutional investors piling into portable alpha strategies will be much more satisfied than those investors who earlier piled into hedge fund of funds in search of alpha. We have little doubt that the frenetic hunt for alpha will continue, but it will become increasingly frustrating for those who think alpha is an easily earned commodity.