- Look to diversify in to alpha
- Investors should look to alpha-focused strategies because they do not depend on market direction
- Equity market beta – the return attributable to the market only – is a volatile and unpredictable source of returns
SYDNEY November 2013 – Investors should look to alpha-focused strategies because they do not depend on market direction and they are uncorrelated or lowly correlated to market indices, a leading fund manager advises.
Pengana Capital’s Damian Crowley says that ‘beta-investment strategies which generate returns mainly due to the market are unlikely to perform as well in the next three to five years’.
Crowley agrees that alpha managers may introduce new risks to portfolios, but he adds, ‘the more fundamentally different risk-and-return drivers that are in a portfolio, the more diversification it has’.
The assumption that markets are efficient and that investors should be ambivalent about the timing of their investment is not borne out in practice,’ he says.
‘Equity market beta – the return attributable to the market only – is a volatile and unpredictable source of returns. It can generate significant gains and losses, and gives limited diversification from other equity markets. Also, timing is everything in this area.’
In contrast, Crowley says, a market-neutral strategy has a low exposure to movements by hedging out the market risk through short positions in equities or equity derivatives such as futures.
‘Because most of the market risk is removed, the returns are generated by the manager’s investment skill, rather than rises or falls in equities overall,’ he says.
This alpha is far more stable, consistent and predictable, he says. The range of returns and maximum peak to trough loss (or maximum drawdown) is far narrower and the correlation with the equity market is negative in a number of periods.
As to the cost, Crowley says ‘beta is cheap, but it isn’t free’. The management of a beta only portfolio can approach 0.5 per cent a year, taking into account market impact, rebalancing, holding costs and commissions.
‘Alpha on the other hand is more expensive, but it’s scarce so arguably it should be,’ says Crowley. ‘Hedge fund managers typically charge higher fees when compared to traditional long-only managers, but expressing the fee as a percentage of the alpha generated puts hedge fund managers in a far more favourable light.’
Damian Crowley
Director of Distribution
Pengana Capital
(02) 8524-9970
0422 466 895
Damian.Crowley@pengana.com
Christopher Hocking
0418 603 694
chris@chstrategies.com.au
chstrategies.com.au
Twitter: CH_Strategies