Tracking the real alpha
Jochen Kleeberg, manging director of alpha portfolio advisors seeks to avoid luck in favour of alpha.
While the search for alpha is the ultimate target of every active manager, in practice, the distinction between alpha, the active return on an investment, and mere luck is a difficult one to make.
However, making this distinction is what has driven Jochen Kleeberg to pursue a business providing selection services. Investment consultancy alpha portfolio advisors was set up by Jochen Kleeberg and his colleague Christian Schlenger in 1998.
Between 2011 and 2015 year to date, it advised on 95 mandates exceeding €6bn on behalf of institutional investors. Being in charge of manager selection, Kleeberg has a vested interest in the performance of his funds, as he is paid in proportion to the alpha generated.
The question, therefore, is to understand what the key criteria are for tracking alpha generating funds.
While the expression: “Past performance is not a guide to future performance” still holds true, being able to observe the performance of a fund against its peers over a long term period helps investors to deduce the probability of underperformance with a relatively high degree of accuracy, Kleeberg argues.
He has analysed the manager universe benchmarked against the MSCI Europe index over a period of three and five years, and highlights that the longer the history of the fund, the more accurate the analysis of its performance.
Nevertheless, external factors such as a change in personnel or sudden growth in assets can have unforeseen consequences.
“Solid forecasts are the engine of alpha generation, a fund manager who is able to make an accurate forecast will be the one who manages to deliver alpha and beat the benchmark. All other tasks in the investment process should be designed to avoid any ‘alpha eating’. This means the forecasted alphas should be translated into a portfolio allocation as efficient as possible.”
Consequently, Kleeberg recommends buying into th process rather than the track record. Qualitative factors such as research, portfolio construction, incentives and risk management are all contributing to alpha generation. “The connection between these factors
can’t be easily deduced from the pure quantitative data,” Kleeberg argues.
He illustrates this dilemma based on an example of two managers with a relatively comparable track record over a three year period. However, when stripping away risk adjusted return factors such as small cap premia, and emerging markets premia through a multifactor style analysis, the real alpha generated by the first manager turns out to be significantly lower than it seems.
On the other hand, the second manager has a significantly lower exposure to value stocks and small cap stocks and in turn a higher level of pure alpha, even though the performance of both initially appeared similar.
The topic of alpha generation can of course not be raised without the issue of costs. In theory, the more complex the strategy the higher the costs. But Kleeberg acknowledges that the issue is much more complex.
“Simple factors such as an Anglo-Saxon name or being a global company can already have an effect on the costs.
Generally, managers from Anglo-Saxon companies tend to charge higher fees compared to German managers, even at a similar performance,” Kleeberg says.
Moreover, precisely because the real alpha is so hard to deduct, charges for active managers can often be disproportionate, he adds.
“Demand for passives does have its justification,” Kleeberg acknowledges. “The average net return of an active manager will hardly beat a passive fund, because the active manager charges a higher fee and trades more.
Therefore if you do not have the ability to pick the right active managers you are better off by investing in a passive fund. The fees of active managers haven’t changed for the last three years. What investors really buy into is the manager’s ability to create alpha, which makes it all the more important to track it,” he argues.