Friday, March 29, 2024
 
Columnist
Martin Hennecke
Paul Ramscar
Formerly Director - Wealth Management at Financial Partners
"One of the more important trends taking place on Planet Fund Manager appears to be the need for managers to justify their charges by providing performance above the normal performance of the market."

Search for alpha among beta
05/07/2010


One of the more important trends taking place on Planet Fund Manager appears to be the need for managers to justify their charges by providing performance above the normal performance of the market.

What this means is that ..the market'' refers to the "beta."

These days, and especially in the highly efficient markets (defined as those in which information on most assets is readily available), matching beta (the market) can be done easily and cheaply.

For example, exchange-traded funds and other forms of trackers could have returned you the plus 20 percent for the year to date on the Dow Jones Industrial Average at a cheaper cost than the average fund manager.

RMB asset managers in London calculate that around 80 percent of ..closest trackers'' or fund managers looking to outperform efficient market indices will have actually failed to do so on a year to date basis.

A recent paper by Mark Kelleher, Jamie Cashman and Jon Platt at Mellon underlines the need to focus on the "easy ways" to get beta to meet the concerns of institutional investors.

They asked: why would this be of importance to only institutional investors? The probability is, if efficiency can be gained and costs saved, why wouldn't every investor be concerned with the subject?

The challenge of identifying, harvesting, and ultimately sustaining multiple sources of uncorrelated alpha has become, in many ways, the Holy Grail for institutional investors, the paper says.

By contrast, beta, or the risk and return of the benchmark itself is often overlooked as easy to obtain, inexpensive, and essentially commoditized.

With the proliferation of instruments such as index funds, exchange-traded funds, and listed and over-the-counter derivatives, the modern investor ideally ought to be able to obtain a given beta easily and cheaply.

For this reason, investors occasionally take for granted that allocating to beta and perfectly tracking it are one and the same.

Whether run as a core portfolio exposure or as part of a portable alpha program, whether intended as a dedicated allocation or as an interim investment designed to hedge risks, managing beta is not as simple a task as it may seem.

Many plan sponsors allocate risk budget to active managers so that they may generate alpha. From their beta exposures, however, investors demand predictability. If the benchmark returns X, the investor normally wants X, not 0.95 X or even 1.05 X.

Consequently, the beta manager's job is to manage active risk, not to spend it. For large capitalization equity, beta managers have it relatively easy, as market efficiencies have created a virtuous scenario where a wide range of instruments make this a straightforward assignment.

Even so, variables such as trading costs, management fees, and index turnover mean the investor must always be willing to assume at least modest tracking error versus the benchmark that they are looking to mimic.

As the investor moves down the capitalization ladder, away from large cap equity, into emerging markets, or toward alternative asset classes, tracking risk tends to grow to the point where beta management may not be appropriate or even feasible.

If nothing else, investors need to be attuned to the possibility that what they believe to be a passive allocation may, in fact, be an unintended form of active management.

So when seeking an asset manager it is not only about performance but adding alpha in other areas such as: regular strategic reviews of your balance sheet as and when you require them; efficient online access to your portfolio at all times: being kept informed of market movements via regular updates; and most importantly using a manager that is not afraid to go against ..the norm.''

DISCLAIMER: The opinions in this article do not constitute financial advice.



Paul's other stories on The Standard:
Held in a grizzly grip - 25/05/2009
China ingredients a recipe for success - 27/04/2009
US insurance behemoths may fall like dominoes - 06/04/2009
Right advice worth its weight in gold - 16/03/2009
Obama's mortgage plan gives little hope - 09/03/2009
Power of one - 16/02/2009
Let corporate bonds reign supreme -12/01/2009
 


Other articles:
Rollercoaster post-recession blues - 17/10/2011
India stocks still good for picking - 06/09/2010
Desperately seeking alpha: how US stocks measure up - 16/08/2010
Tap in as sleeping giant awakens - 12/07/2010
>> Search for alpha among beta - 05/07/2010
Crisis fails to temper desire for opulence - 14/06/2010
BRICs build sturdy foundation on their own - 31/05/2010
Get real when the market throws a wobbly - 17/05/2010
It・s complex when bulls and bears share the same cage - 03/05/2010
Five questions to ask your adviser - 19/04/2010
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