FROM CEO/CIO: WHERE CAN I FIND ALPHA?
Where I went to university, my essay grades were given in letters of the Greek alphabet: alpha (α), beta (β) and gamma (γ) and combinations of them – including esoteric ones like beta-alpha-minus-question mark-minus (βα-?-) ! Without question, alpha was better than beta and a straight alpha was almost unheard of!
Perhaps academic instincts have lingered among those who have become fund managers and investors, because a whole global industry has grown based on seeking alpha, i.e., superior performance over the market portfolio. Yet for many fund managers, alpha has been frustratingly elusive especially in the last 10 years or so. To where has alpha gone?
Recently, the MoneyOwl team, together with principals from NTUC group and Providend, our two corporate parents, had the privilege of sitting down with Nobel Laureate Professor Robert Merton, who is Resident Scientist at Dimensional Fund Advisors. Professor Merton suggested that we need to understand that there are actually different sources of alpha, namely:
- Traditional alpha: This is premised on market information inefficiency, and is sought through active or dynamic shifts in asset allocation (macro readouts, market timing and so on), or through micro selection (e.g. stock picking). In other words, traditional alpha is achieved when you are smarter, better and faster. This is what so many seek, but so few delivers.
- Financial services alpha: This is alpha captured through the ability to reduce market frictions and institutional rigidities. This includes the ability to execute trades most cheaply, to earn securities lending income, leverage up due to lighter regulation and so on. Hedge funds have traditionally managed to do so. Dimensional funds, by maintaining large, liquid portfolios, also earn financial services alpha.
- Dimensional alpha: These are alphas that exist even in perfect-market and efficient-market conditions that are supported by financial economic logic, persistent (statistically significant over a long history of 50+ years), pervasive and continuous. Dimensional Fund Advisors have identified and implemented some of these dimensional alphas and tilted their market-based portfolios towards them, namely, size (small caps beat large caps), value (value beat growth) and profitability (high profitability beat low profitability).
Many hedge funds and banks have struggled, especially after the Global Financial Crisis, to generate continued alpha. This is because their alpha was not actually a “smarter, better and faster” traditional alpha, but financial services alpha, which quickly disappeared in the Crisis as their credit lines for trading and leverage disappeared and heavier regulation set in.
A key tenet of MoneyOwl’s investing philosophy is to stay invested in globally diversified portfolios to capture market return, while keeping costs low. We do not take fund manager risk, or in other words, we do not gamble your money on fund manager hubris – not that it is impossible to generate traditional alpha, but that it is very difficult to do so and to do so consistently. It is a little ironic that Dimensional funds, while built on the basis of the work of multiple Nobel prize winners, should disavow being “smarter, better and faster” than the markets, while many others over-promise, yet under-deliver.
Finally, MoneyOwl seeks to deliver to you alpha beyond what the funds we have selected can do. By augmenting human advice with technology, we have made accessible to the ordinary investor best-of-breed funds at low cost, starting with as small a quantum as a monthly investment of $50 – that’s our financial services alpha for the man in the street, the reason for our existence. And more importantly, it is our job to be your risk coach, to provide consistency and comfort amidst the turbulence of markets, to help you stay invested in a portfolio suited to your need, ability and willingness to take risk, so you do not sell your investments too early and miss out on the market upturns – that’s advisor’s alpha.
Chuin Ting Weber, CFA, CAIA
CEO & CIO, MoneyOwl