Blazing the alpha trail for diamonds
Manager selection is a special skill that ABP is bringing to a fine art. “If we do not have a group of people to identify external managers by using as much as possible our internal knowledge and skills, we would never get to the real diamonds out there,” says CIO Capital Markets Jan Straatman, emphasing the importance of this role in the search for alpha.
Michael Stam is the fund’s bounty hunter for high alpha managers, seeking out those who are unique with that something special to offer and then to measure and compare their skills as would be done for ABP’s internal managers.
“We want to find managers who can create alpha. We are not too concerned with the underlying beta, as we can hedge the underlying market exposure. So the focus is on new, exciting and often capacity-constrained ideas. As where the opportunities are limited it dos not make sense to build up the expertise ourselves,” says Stam
The first internal step is that of identifying in which area an external manager would be beneficial. “In that process we look at markets where the median manager outperforming the overall market. With first quartile managers, we have a real potential,” says Straatman.
The process of doing this is structured one and once the particular area is identified, a long list of names is created. “These can come from databases, the internet is a great provider, and we have now our own proprietary database,” says Stam.
These managers are then invited to ABP to present their capabilities. “They explain what they do, they put it in a database, so when we are looking at a particular area or strategy we can pull managers from our data base.” This can be buttressed with input from Wilshire and other searches such as through IPE-Quest.
The huge information flows that come ABP’s way needed to be standardised. “This is why we have our website, where we have a standardised questionnaire focusing on the investment processes and the performance. The website feeds into a database, which is at the heart of the whole system.”
The systems use the diagnostics from the quantitative portfolio to analyse the external managers and have provided ABP with a big advantage in this task.
Then the diagnostics come into play once the data has been collected. The first of these is an environment analysis, says Stam. “This looks at the environment we have identified in different markets. This enables us to look at how the particular mandate would have performed in different market circumstances.” The first task is to see if the strategy really “makes sense in the light of the market environment”. It also highlights the diversification benefits that mangers could bring.
The second step is that of ‘Return-based style analysis’. “Since we have quite a number of managers on the database, we do this analysis on these. The aim there is to sort out the ‘pure alpha’ of the manager,” Stam says.
The objective is to see what are the underlying structural factors a manager keeps in his portfolio. “Is it a value tilt, a small-cap tilt, is it a momentum play?” Stam says this tool is sophisticated one using a range of statistical techniques. “It tells what really drove the past performance, was it stock selection, market timing, high beta stock low beta cash levels and so on.”
He adds that this can provide good points around which to start discussions with the managers. Stam adds: “Quants usually know what’s in the portfolio, but fundamental managers sometimes need to be made aware of what exactly they are doing.”
Another aspect that is important in selection is the extent to which there are hedging instruments for any particular strategy. He gives as an example whether a South African manager is correlated to the gold price and what could be done to hedge out if required.
The focus is on long and long/short products, as there is a separate alternatives platform for hedge fund managers,. “But we are increasingly looking at hedge fund managers to see if they can implement strategies for us. Or even find a small manager we can team up with to develop a strategy that works for both of us,” says Straatman.
Currently, there a “several hundreds” of managers on the database and the aim is to extend this to include firms coming within ABP’s parameters.
“As with our internal managers, we are not worried if only interesting managers can be identified in Australia, we buy as many as we can and then hedge away through the overlay as we do with internal managers. So we may have a South African manager who does not know they are creating alpha for Japan.”
“It is an area where the cross-over of knowledge and intelligence has worked well. We now have a team of experienced portfolio managers who are involved in manager selection,” Straatman says, adding it is no way inferior to use their skills in this way rather than directly managing money.
“To understand the really complex strategies that these managers present really requires this level of commitment.”