Where to really find alpha (and things like it)
There are only five things you can add to a portfolio to help it out, says Michael Block: equities; factor exposures; duration; credit (though spreads are currently “very, very skinny” and the asset class is highly correlated to equities); and finally skill – or alpha.
“We have an opportunity to move away from equities and other assets that are overpriced and towards managers and strategies that can add skill,” Block told an Alternative Future Foundation event last week. “I thought and still think that the aim of any investment program is to generate excess return. If those excess returns are skill-based – or alpha, Jensen’s alpha – and uncorrelated with other parts of the portfolio then that’s something worth having.”
The place to look for alpha, Block said, is where you can get good value for your money and where there’s a reasonable chance of success – which excludes large cap US equities. There’s strong evidence that the vast majority of managers underperform the index after fees. Super funds have struggled to construct their own active international equity portfolios, while Mine Super, where Block is currently consulting, is close to the top of the leaderboards – and passive.
“Private markets are a great place to try; less well researched markets where skill can build make a difference are a great place to try; highly regulated, very well researched markets are a poor place to try,” Block said.
At Australian Catholic Superannuation and Retirement Fund and Mine Super, Block was passive in international developed markets and active in Australian markets because managers have a fighting chance of beating the ASX. Some of that is because the indices are “rubbish” (both the 200 and 300 contain 11 per cent REITs, and the way the ASX accounts for pricing of floats is suboptimal) but allocating to Australian equity managers is still “a good thing if you want to get alpha”.
“The evidence (in small caps) is very strange,” Block said. “In global small caps, the beta has beaten the large cap – but the managers haven’t done that well in terms of alpha. In Australia, the managers have done exceptionally well; the average Australian small cap manager earns 4-6 per cent above the small ordinaries, but unfortunately the beta has performed exceptionally poorly.”
Emerging markets are a great place to generate alpha, but their equities have performed poorly over the last decade; even if you’d beaten the index by five per cent per annum, you still would have lost to the S&P or ACWI. Block says that if he were invested right now he’d be underweight US, overweight Australia in equities – but underweight equities and overweight bonds and credit; particularly private credit, with the caveat that the credit is any good.
“If you’re a purist and you want to get pure as the driven snow alpha-like returns, I’d go for insurance-linked strategies and trend following strategies or CTAs, and if you put that together I think I’ve named the kinds of strategies that ACS used to have,” Block said.
“The only controversial thing I’ll say is that there are some things which I don’t think are asset classes; I think people are now getting too granular, and I don’t believe infrastructure is an asset class. It’s really just a weird mix of equities and inflation-linked bonds. If you’re investing in global listed infrastructure, it’s a poor place to find alpha because there’s not enough breadth in the market. But if you just want to beat inflation by a certain number it’s an okay thing to think about.”