The World Wakes Up To Alpha-Centric Investing

by: Christopher Holt

Two stories this week show that alpha-centric investing is taking hold. The first is the release of a new white paper by Casey Quirk and Merrill Lynch. The report says that “Active alternative investments, including hedge funds, will more than double to around $11 trillion by 2011…”

The report contains what the authors call “four winning product strategies” that will define success in the asset management industry.

1. “Liberating the Efficient Frontier through products that eliminate all investment constraints for which there is little economic rationale, such as liquidity of issues, style box adherence, no shorting and no leverage.”

Cited Example: Removing short constraint (130/30) (Postings, News Archives)

2. “Packaged Solutions that combine the strategy and execution components of the investment process under one roof.”

Cited Example: Unified Managed Accounts (UMAs) (Postings here & here)

3. “Outcome-Oriented Products and capital-protected and income-oriented vehicles.”

Cited Example: Liability-Driven Investments (NYSE:LDI) (Postings, News Archives)

4. “Creative Funding Solutions that address funding gaps in both retail and institutional markets.”

Cited Example: Selling off pension liabilities to the market or a third party (News Archives here & here)

The second story in the news that leads us to believe the world is unfolding as it should is this piece in Investment News about alternative investments and ETFs “depleting stock funds”.

According to Investment News,

Investors’ increasing appetite for ETFs and alternative investments is sapping money from stock funds — a trend that some say could last for several years.

Apparently, net inflows into US equity mutual funds are basically zero. In fact, net inflows into these funds are usually correlated to US equity performance. But since January 2004, this historical pattern has ceased.

Andrew Clark of Lipper tells Investment News, “It’s very puzzling…Something major has happened here.”

And Patrick Becker of the $2.5 billion Becker Capital says, “There has been a large asset allocation shift away from large U.S. equities and into private equity, hedge and alternatives in general, and international.”

Becker’s observation is backed up by McKinsey’s recent study of asset managers that concluded traditional asset managers were caught in a “vise-like squeeze” between high alpha and cheap beta funds (and also by Casey Quirk’s observation in 2006 that traditional managers will be caught in an “alpha-beta squeeze“).

And so it appears the world is unfolding as the experts had predicted.