In our interview Novogratz suggests what institutional
investors hate to hear and what many managers I spoke to for
this story wouldnt say on the record: Hes
Its hard to teach young traders this, he
says, referring to macro investing. Youre either
good at it or youre not. Most asset managers
wont say theyre smart at least, not in
public because their investors want to hear about a
formal investment process that can be taught and repeated. They
want alpha to be sustainable. Of course, if the process of
delivering alpha can be easily documented, others can
and will copy it, and returns should go down over
After the conference I chase down Cliff Asness again. It
took me some time to fully understand his wavering between
agreeing with me that alpha is tougher to find and asserting
that its always been hard. Then it came to me that Asness
has survived in the hypercompetitive world of investment
management by redefining alpha altogether. As head of quant
research at GSAM in the early 90s, he had a front-row
seat on the decline of alpha. He was among the first to
commercially exploit the then-new ideas on value and momentum
investing written up in academic literature, and he watched as
others copied the strategy. But Asness has invested heavily
over the years to keep AQR ahead of fierce competitors. In some
ways, for AQR, alpha hasnt gotten harder to find, but
thats deceiving given the scope of research and
development efforts designed to give it an edge.
AQR offers an enhanced version of the strategy Asness
pioneered at GSAM, but the firm is transparent with clients
about that and charges far less for it than would have been the
case 20 years ago. Asness explains that the strategy improves
portfolios risk-return characteristics, even if its
not technically alpha in the sense of a secret sauce that no
one knows about. We use the phrase Its alpha
to you, he says.
Asness emphasizes that systematic risk premiums that look
like alpha owning cheap stocks and shorting expensive
ones, for example still work. I mean
work like a statistician means work
more often than not, he says. If your car
worked this way, you would fire your mechanic. For those
strategies AQR has separated alpha from beta and offers cheaper
beta solutions for clients.
Even as alpha has been weakened by
trading advances, managers can add some of that back.
J.P. Morgan Asset Management considers its buy-side trading
prowess a big part of how it delivers alpha. Being able to
skillfully trade and implement a strategy efficiently has
become more difficult. But managers can either watch some of
their alpha erode from a lack of an investment in this area or
they can make sure they have trading skill that adds to
Even with all the examples of excess returns still being
available, State Streets Duncan is done with alpha.
For the investment industry to make money going forward,
performance has to be redefined, she says.
Performance is personal. Duncan, who along with her
team has conducted several hundred face-to-face interviews with
investors, believes that portfolios should be designed based on
an individual clients unique set of risks, benchmarks
need to be customized, and comparisons to major indexes should
be eliminated. Bills cant be paid with excess returns,
she explains; alpha is extraneous.
Georgia investor Willis, who bet me dinner he could persuade
me to drop this story altogether, says it doesnt matter
if alpha is dead investors of all stripes are just too
impatient to stick with any strategy long term. Hes
convinced that complexity is the enemy of alpha by introducing
new risks and a lack of understanding as to what is actually in
a given portfolio.
So I go back to Ellis. He too has been advocating that
investment managers return to the business of providing
tailored advice. He says its the one service they can
consistently deliver. Managers who promise steady
outperformance cant make good on the pledge. But
what about David Swensen, I say, trying to speak softly
as my voice booms in a cavernous room on the second floor of
the Yale Club in Midtown Manhattan. How can you so
staunchly believe that investment managers cant
outperform, when you watched David do it for so many
years? (Even with the losses of 2008, Yales
endowment returned 13.7 percent a year over the two decades
ended June 30, 2012.)
Ellis is undeterred, making the case that Swensens
skill is not unlike that of a Picasso or a Renoir.
Hes the most rigorous thinker about investments in
the world, says Ellis. He starts to go on, then pauses.
The great thing about Ellis is that he doesnt just tell
one story to illustrate his point; he tells many.
He says that when he learned how to race sailboats when he
was a kid, he was taught never to follow the leader.
Hes already beaten you, he explains.
You have to do something different.
Ellis notes that only after reading Swensens
Pioneering Portfolio Management a couple of times do
you realize how the Yale CIO thought through the entire
investment process, from protecting his portfolio to assessing
the characters of the investment managers he hired. Then Ellis
takes me back to his first job after graduating from Yale in
1959, when he managed WGBH-FM in Boston. Julia Child, the woman
who brought French cooking to the U.S., was just getting her
career started with WGBHs TV station. Child became an
icon as Americans fell in love with dishes like coq au vin,
trying to emulate her complex and time-consuming techniques in
a world that was getting its first taste of TV dinners. Ellis
smiles and says, After watching her, people always
wondered why their creations werent as
Chefs cant learn their craft from the couch by simply
imitating the steps of Julia Child any more than investors will
uncover the secret to finding alpha by mimicking the moves of a
Peter Lynch or David Swensen.
Watch Our 'Is Alpha Dead?' Video Series