The Future of Active Asset Management
for Defined Contribution Plans
Jerry Bramlett
EBRI Policy Forum
May 8, 2008
Alpha vs. Beta
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Alpha
– The sum total of alpha is zero
– Seeking alpha: a zero sum game in which one investor can achieve gain only
at another investor’s expense
– Alpha is mostly random
It is hard for the average investor to see through the statistical fog and easy
[for them to be] fooled by randomness. But small investors really ought to
worry about cost.
– The Economist, April 2008
– The term “alpha” is often misused
• Alpha cannot be produced, mined or harvested
• The concept of “portable alpha” is key example of the term’s misuse
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Beta
– The value that the “real economy” creates
• Market appreciation of stock
• Income (e.g., dividends, coupon payments on bonds, etc.)
– Beta may not represent the return that the investor is seeking but it will
always be what the market delivers – no more and no less
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Chasing Alpha
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•
Alpha has become increasingly hard to capture for the average DC plan sponsor
– 10,000 hedge funds, 14,000 mutual funds and thousands of separate account
managers all looking for mispriced assets or arbitrage opportunities
• creates enormous competition
• drives up the cost for finding any inefficiencies that can be exploited
The cost of money management has skyrocketed over the last couple of decades
effectively erasing above-market returns
“If the present level holds for the next decade … total intermediation costs
would come to a staggering $5 trillion. Then think about these cumulative
costs relative to the $16 trillion value of the US stock market and the $12 trillion
value of our bond market. Those costs would represent an astonishing
18 percent of that value.”
– John Bogle, Black Monday and Black Swans, 10/07
“The hunt for alpha seldom recovers the cost of the expedition.”
- The Tao of Alpha (Tammer Kamel, iluka Hedge Fund Consulting
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The Zero Alpha Approach
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Zero Alpha
– No attempt is made to achieve returns above the actual return
produced by an asset class
– The focus shifts to the secondary level of portfolio management –
asset allocation
“Approximately 94 percent of variability
of a fund's investment return is due to
asset allocation.”
- Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower,
Determinants of Portfolio Performance," Financial Analysts Journal,
July-August 1986, Follow-up study, "Revisiting Determinants of
Portfolio Performance: An Update," 1990 Working Paper, 1986, 1990
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The Advantages of Zero Alpha
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Dramatically lower costs – 1-3% depending on the investment vehicle,
trading level, and the fee charged by the alpha-seeking manager
– These lower costs, after a lifetime of saving, can add 40-60% to an
individual’s retirement income
•
Guaranteed market returns
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No revenue sharing
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No “style drift” – enhances the effectiveness of the asset allocation
overlay
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Enhanced transparency (there is not much to look for)
•
Bullet-proof from a plan sponsor/fiduciary perspective
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