Just another Snark hunt?

June 25, 2009

The Lewis Carroll poem The Hunting of the Snark (An Agony in 8 Fits), follows the misadventures of a group of seafarers, amongst them a banker and a broker, as they search for the elusive mythical beast. We are warned at the outset that catching Snarks is all well and good, but beware if your Snark is a Boojum, because – well, we’ll come to that.

Alpha looks set to become as equally elusive in the next 20 to 30 years as investors switch to passive investing and exchange-traded funds (ETFs) in greater numbers, and the amount of information available to all market participants increases.

Suzanne Duncan, financial markets industry leader at the IBM Institute for Business Value, argued at the Fund Forum in Monaco this week that some 85 to 90 percent of investment returns in the next 20 to 30 years will be beta returns, as investors become increasingly disillusioned with paying for actively managed funds that fail to deliver.

“Only 15 percent of long-only active managers have outperformed their stated benchmark over the past 5, 10, 15, 20, 25, 30 or even 40 years,” she says. Yet some 70 percent of the world’s assets under management is currently invested in traditional long-only active strategies.

Duncan believes alpha will become increasingly hard to find as transparency – that is, nearly instantaneous and accurate information – increases. “Some academics are sceptical that there is such a thing as alpha anyway,” she says.

Mark Tennant, senior adviser to JP Morgan Securities Services, points out that it is no longer as simple to add alpha in developed markets as it was in the 1970s, because more market participants have access to the key information at the same time.

“Asset managers need to recognise where they can add value and where they can’t,” he says. “For example, I don’t think simple long-only equity products can add value any more, unlike in the 1970s say, when there was less information available to all.”

He believes that ETFs will take over a lot of what asset managers do. “That means managers need to take a huge step back and ask if the products they put out in the last 20 years are the right products for the next 20.” 

Duncan added that as emerging markets like China become more like developed markets, with greater transparency, market efficiency will increase and it will be harder for managers to deliver outperformance.

This sets the questing asset manager a conundrum. Do you give up searching for the ever more elusive alpha and throw in your lot with the beta players? Or do you bet the farm on the hunt for alpha and hike your fees, hoping you can persuade investors to pay up?

Carroll’s hunters meet with various unpleasant fates – the Banker loses his sanity after being attacked by a Bandersnatch – but the worst fate of all is saved for the Baker, who believes he has discovered a Snark. Sadly, when the others arrive, he has vanished into thin air, “For the Snark was a Boojum, you see.”

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