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By Clint Coghill

Two months ago, I had the opportunity to moderate a panel at Agecroft’s Gaining the Edge hedge fund conference called, “The Arms Race to Alpha.” My co-panelists consisted of asset owners who allocate to hedge funds: Alifia Doriwala of Rock Creek, David Gilmore of The Harry and Jeanette Weinberg Foundation, Karen Inal of The Andrew Mellon Foundation, and Robert Kiernan of Advanced Portfolio Management. We got together on stage to talk about the innovative ways they’re seeing hedge fund managers drive alpha, and I thought I’d share the most illuminating takeaways from our session.

ASSET OWNERS ARE GETTING CREATIVE IN SEEKING ALPHA

I kicked off the panel by asking the panelists what they were seeing as key sources or trends in generating alpha. Their responses demonstrated how each of them were getting creative in reaching untapped alpha:

  • Education and healthcare in emerging markets and private markets.
  • Getting into neutral markets where the Beta is close to zero, such as energy.
  • Building a real estate portfolio where liquidity is less of a focus.
  • Identifying intriguing distressed markets, such as trading and credit.

When I asked each of them to describe an example of a manager with an edge, I also got a wide range of interesting responses:

  • Data intensive strategist who knows what to sell in the secondary market.
  • Creative thinker who focuses on impact investing and sustainability, such as real estate communities with low rent.
  • An expert on the energy markets who is flexible with their long and short positions.

And perhaps the most interesting answer: a manager who focuses on music royalties – after all, Netflix and Hulu are constantly in need of music content, which creates a consistent stream of cash flow. All of these specific examples show just how creative managers need to be to stand out from the crowd.

GOOD MANAGERS DON’T JUST COLLECT DATA, THEY DECIPHER IT

I asked the panelists for their perspective on how their managers are handling the increasingly massive influx of data.  While the panelists agreed that good managers are obsessed with achieving an information advantage, they sounded cautionary concerns that the information itself was not the end-goal. A couple of comments that particularly struck me were:

  • Insight is the goal with data.  Artificial intelligence and machine learning can ‘cause noise.’ In a trade war, I see more danger with the obsession around data.
  • Data is the new buzzword. Data and technology are so important in both fundamental and quantitative strategies, but we need analytics to quantify results. Artificial intelligence can find trends or sentiment and discern micro trends. It’s important to know how we are using data in continuously creative ways.
  • I question how much trust portfolio managers have in data, and it is important to know how they will then use it. Data’s value needs to be proven by results.

PEOPLE ARE STILL DOING BUSINESS WITH PEOPLE.

I thought to ask the question, “How do you source managers?” I wanted to understand how asset owners are finding talent in today’s Information Age. It turns out, business is still getting done the old-fashioned way – by meeting managers through networking and relationships:

  • We network to reach untapped areas of interest through existing relationships.
  • We network based on investment themes. We also talk to other LPs who have been around a long time.
  • We network at conferences and with membership organizations. Hedge funds are shutting down, and it helps to identify talent early as it’s more effective to be someone’s first client, as opposed to their 15th.

WHEN IT COMES TO FINDING AN INFORMATION ADVANTAGE, CREATIVITY IS KEY.

According to the panel, there is no question that hedge funds are experiencing the effects of a volatile market and not performing as well as expected over time. A select group of managers, however, have used an information advantage to evolve and enhanced their investment processes to stay relevant. I wanted to probe the idea of an information advantage a little further, and the theme of creatively using data was prominent.

  • We must get creative to find the resources to access applicable data that our competitors don’t have.
  • Point of sale data and satellite imagery are currently interesting paths. We’re also tracking metal inventory and retail and have teams dedicated to scraping the data off the web and providing it to our managers. Research is key.
  • We’re seeing more potential with international managers and regional managers. Investors trust managers who are from their region and feel they have a better understanding of what information is applicable to their portfolio.
  • Emerging markets are a good opportunity for developing an information advantage.
  • You have to be creative in finding the information you need that impacts your trading strategies. For example, you might need satellite imagery for traffic crossings, which is not made publicly available. So you might need to access this data through memberships in associations or through proprietary databases.

DIFFERENT ASSET OWNERS WORRY ABOUT DIFFERENT RISKS.

When it came to risk management, there were as many perspectives as there were panelists. I thought I’d share those perspectives here:

  • Volatility is a key risk for us. Where markets are not dominated by massive flows, managers need to know the existing risks and prepare in advance. The speed of trading is much faster now and you have to keep up.
  • Technology – it needs to be used to understand data quantitatively and qualitatively. It takes technology to make better decisions.
  • We can’t lose capital when equities fail, so having a diversified portfolio is key. We can’t let ourselves get too illiquid – we can end up paying fees for getting out of an investment early or forcing sales at the wrong time.
  • Drawdown risk is the largest risk for us. There is a lot of beta and liquidity risk that can negatively impact foundations.

IN SUMMARY

I want to thank all of the panelists for an informative and thought-provoking session – it’s clear that while everyone wants to find alpha, they need to have not only creative portfolio strategies, but also optimized data and information management strategies in order to execute flawlessly. This dovetails with the reason I founded Backstop Solutions in the first place – to help asset owners and managers alike leverage their data most effectively.

To learn more about Backstop Solutions, please contact us today.