1. APRIL 29 2002
THE INVESTOR’S ALTERNATIVE ALPHABET: ALPHA VS.
BETA
by JM Bloch
Return is a function of a given market or asset class, this is one definition of beta.
Relative return (beta) strategies enjoy good reputation with conventional merits.
However, they have two unconditional limits to their success: when markets fall or
move sideways. How do investors adhere to beta strategies?
Keynes’ maxim answers, “Worldly wisdom teaches us that it is better for reputation
to fail conventionally than to succeed unconventionally”.
The boom sequence that occurred from December 1992 till March 2001 on global equities could be labeled
as a case of “beta hunting”. The market rose, rarely pausing, then recovering rapidly from major turmoil
in Latin America (94), Asia (97) and Russia (98). During this decade, beta hunters have continuously
looked for booming sectors, hot IPO’s and emerging markets. The world was increasingly growing smaller.
Ensuing merger mania was reaching its climax. Sure it was time for prudence. Risk had become a
forgotten concept with ignored principles and consequences.
Thus came the bust in 2001: equity markets collapsed, which impacted on other asset classes and global
economy. The “new economy” turned out to be an old paradigm, one of conventional market failure.
“Blind economic adherence, plus leverage, lead to boom-bust mania” wrote Soros in 1987.
Since March 2001, just reverse the “beta merchants” attitude that prevailed in the nineties to understand
the current posture: re-assessment of risks, search for companies with quality earnings, cash and low
debts.
Is it time to put back the investor’s alphabet in order? It seems the new paradigm brought back good old
economic values, after all. Except for one change, alpha was reborn. Alpha is the variation from market
return that comes from skills. Although the concept dates back from 1949 (A. W. Jones), its scope is of an
entrepreneurial nature. Skill-based returns differ from just stock-picking and market moves. Skill-based
returns are about investment philosophies and strategies searching to exploit markets inefficiencies by
controlling risks and not only the attempt to be smarter than markets. Traditional money managers are
restricted on investments, while alternative managers use more advanced risk-management and financial
engineering. Since they have to understand the evolving nature of risk along with the markets’ structure,
alternative investment managers are “alpha producers”. They rely on skills and motivation. To protect
investors’ assets, absolute return (alpha) strategies are dynamic and adaptive, with latitude and flexibility
in constructing portfolios that succeed in all market conditions.
JM Bloch
Investment Manager
Alchemy Capital Management Ltd.
HEDGE FUND ASSOCIATION
Tel: 202-478-2000 Fax: 202-478-1999
info@thehfa.org
Page 1 of 1Hedge Fund Association
1/14/2003http://www.thehfa.org/NL_Gate.cfm?Cnt=84&NID=9&Track=Archive&ID=22