Ahead in 2007
1.Is the pursuit of alpha a realistic strategy when few true alpha strategies are scalable, when there are several definitions portable alpha in circulation and where trustee knowledge of underlying investment approaches is limited??
2. Do you accept forecasts that suggest we will remain in a low-return environment for the rest of this decade?
3. Is the general quest for absolute returns realistic or are they a finite resource and so is their pursuit destined to end in tears?
CEO at Denmark’s Industriens Pension
1. Over time some alpha sources dry out while others will emerge. We expect that pattern to continue in the future. In our search for alpha sources we carefully judge whether the strategy delivers true alpha or just ‘beta in disguise’. We regard building trustee knowledge as an important step stone in the implementation of alpha strategies. It is important that everyone in the organisation is comfortable with the investment strategy we follow.
2. Yes, we do believe that we will remain in a low-interest environment for a longer period.
3. Some investors believe in active asset management while others do not. We belong to the former school and historically we have been successful in pursuing that path. Basically, we see absolute return strategies as an advanced version of traditional active asset management and we do believe that new alpha sources will emerge going forward. We believe that skill and thoroughness will be rewarded, but are very well aware of the fact that there will be a huge dispersion in returns from top quartile and bottom quartile managers. Manager selection is and will continue to be king - and that is where we focus our resources.
Deputy managing director and CIO at
SEB VB Investiciju
1. Alpha can be generated provided there are market inefficiencies and skilled managers. Greater market inefficiency in emerging markets makes pursuit of alpha more viable there than in developed markets. However, this strategy has its disadvantages: it is hard to sustain, it might be limited in scale and it might be misunderstood. The alternative for all, or at least for developed markets investing, is to look for efficient beta solutions.
2. Yes, that is quite possible. Excess liquidity may drive asset prices higher and prolong a bullish trend in equities for a certain time. However, it would be erroneous to believe that it would ‘go a different way this time’. Once the cycle turns we might see global stagflation fears again and that may enforce a low return environment in most asset classes.
3. Absolute return is a vague concept with differing definitions and so is often misunderstood or it effectively hides relative returns. However, a quest for pure alpha (for example, in market-neutral portfolios) may be a zero-sum game that would inevitably lead some players to a defeat. A sustainability problem combined with exaggerated costs may lead to a bad result. Thus, a ‘quest for absolute returns’ is no panacea, but may be used to add value to more conventional beta investing.
chief executive of the UK’s Superannuation Arrangements of the University
of London (SAUL) Trustee Co
1. Yes, but the key task is to define the alpha. If alpha is ‘out-performance’ then what the alpha is out-performing is the key starting point. Alpha does not necessarily have to be achieved entirely through portable alpha approaches - so the question of definitions is not really important. Trustee knowledge of new investment approaches is limited and that will lead to disappointment because to achieve the best alpha will require use of innovative investment strategies and investment in new asset classes and many trustees do not have the knowledge to identify and assess their relevance.
2. Yes, all the indicators are that this decade will be one of low inflation and low returns. Mean-reversion would indicate that 15-20 years of historically high equity returns will be followed by a similar period of historically low equity returns, and there is so much pressure to buy bonds that yields in that market will also remain depressed for some time to come.
3. Absolute returns are not a finite resource, it just depends on the level of return that is being sought. There will be some who are disappointed in the search for absolute return when that return is lower than a market index would deliver.
Head of business development at Schroders Portugal, Lisbon
1. The implication of the question is that alpha is a fixed quantity only found in esoteric pockets exploited by a few highly skilled managers. In fact for every trade there is a winner and a loser, so by definition alpha is zero sum. The issue is the amount of alpha, which in efficient markets can be very little, and the ability to harness it, which can be expensive. While technology will continue to improve market efficiency, unless all market participants have the same restrictions, information set and goals there will always be winners (positive alpha) and losers (negative alpha). The challenge is to separate and harness the two.
2. Looking at what current markets are discounting, we are likely to be in a relatively low return environment. The drivers of the previous decade - disinflation and technology boom - are largely spent forces. Long-term yields are low, valuations reasonable, breakeven inflation rates are modest. 3. Absolute returns are a strategy that basically just affects your approach to managing risk, and hence it is sustainable. There is no magic to them (after all treasury bills have provided an absolute return for a century or more). The challenge what level of absolute returns - that is where the rubber meets the road.
CIO of Crédit Agricole Asset Management (CAAM), Paris
1. A strategy based on the quest for pure alpha may be fashionable but is fairly unrealistic. Identifying pure alpha from simple beta is a difficulty that most serious professionals acknowledge. Alpha is unstable and should be considered as an additional return once the portfolio has been constructed properly.
2. Global excess of liquidity chasing yield on a relative-value basis has eroded returns across the entire asset spectrum. Bond markets were hit first and are now priced for perfection. You cannot invent disinflation twice and there is no structural engine to drive bond value further. There is some repricing in the bond market ahead. Investors will have to go through this difficult period, where alpha is destroyed, to restore the bond alpha pool. Returns on equities should benefit from a healthy fundamental backdrop and PER expansion. Equities are the last stop of the big liquidity wave, and there is some way to go before entering stretched territories.
3. The sharp increase in absolute strategies makes it more difficult to precisely define what they are or should be. The ability to stick to the basics of absolute return management and to capture alpha on a sustainable basis is key. Some will end in tears, others in heaven.
Chief investment architect of Pictet Asset Management, Geneva
1.The pursuit of alpha cannot be a realistic strategy for the industry as a whole given that it is a zero sum game before costs. This does not mean, however, that it cannot be a very realistic, highly successful strategy for a minority of asset managers and their clients. Confusion about definitions and limited trustee knowledge are minor obstacles.
2.Many investment houses publish medium-term return forecasts that are usually given away and that is probably a fair price since the precision of most such point forecasts is dismal. But, given the exceptionally high returns of the 1990s it would not be surprising if this decade’s numbers were closer to the long-term average and therefore lower.
3. Absolute return means different things to different people. But it often involves switches between risky asset classes and cash to preserve similar (positive) return levels regardless of the market environment. The switches constitute market timing, an active strategy, and that can again only work for a minority after costs. The majority that loses will necessarily be just as disappointed as they were with traditional active management but, since there is no clear benchmark, it will take them much longer to realise it.developed world markets.
Senior investment consultant at Watson Wyatt, Dublin
1. The pursuit of alpha is a zero sum game so it is important for funds to carefully assess their governance budget with a view to gauging how successful they are likely to be when following such an investment strategy. We would contend that of the three governance models - a cost minimiser with a single board and a limited governance budget where the focus is on avoiding value destruction; a diversity seeker with an investment committee having some governance budget best deployed in diversified beta gains; and a diversity and skill exploiter with a CIO and investment team where a governance budget can produce significant value from multiple sources - only the third is likely to achieve value from following portable alpha strategies.
2. Pension funds have moved a long way in the past five years from focusing on returns to the exclusion of everything else to implementing more holistic investment strategies involving risk budgeting that can be efficient in a variety of return environments.
3.Absolute return investment is a key development, involving separation of alpha and beta drivers to investment return. Best practice is focused on diversity in investment strategies. However, reference to governance budgets is required.
Investment Consultant at
Hewitt Associates, Amsterdam
1. Yes. However, understanding the risk and return characteristics of different alpha strategies and their impact on overall risk are the key issues. It is true that there are capacity constraints on alpha products and therefore a timely decision-making process for investing in such products is required. Having the right framework for assessing alpha strategies is important for decisions in the right timescale.
2. We expect inflation to remain at quite subdued levels in an historical context and therefore nominal returns may appear low compared to what we have seen in the past. Real (after inflation) bond yields are around 2%, which is on the low side so we doubt there will be much of a capital gain to boost the income return. Relative to bonds, equities represent good value on a medium- to longer-term view .
3. Provided fund managers can provide the necessary alignment of client interests on fees, we believe these strategies will play a larger role in portfolios. The growth in the number of such strategies being offered places a greater emphasis on the ability to identify the most suitable products. With the right manager research resources and process, this is achievable.
Managing Director at Aon Consulting, Stockholm
1. We do still believe that alpha can be achieved with the right investment vehicles and strategies. However, the really good alpha strategies and managers should probably be seen as scarce. So as more money seeks alpha the possibility to actually produce it decreases. Various definitions of portable alpha have one thing in common: the separation of alpha and beta risk and return. But different definitions are not a big problem as long as trustees are clear about what they want.
2. We believe that the current applied asset return assumptions are more sensible. Equity risk premiums are often set lower than before, which reflects a realistic view of equity returns going forward. Low risk premiums together with low interest rates lead us to have lower expectations on asset returns.
3. An absolute return strategy at a portfolio level is important for a pension fund. As more and more pension funds look to LDI strategies to immunise interest rate risk they will be left with a cash benchmark. That means that the return-seeking part of the portfolio will have a benchmark of cash-plus rather than an equity index. If we spell out the objective to benchmark the risk and return of asset managers on an absolute basis clearly, I think we will have opened up new interesting investment strategies.