Over the past decade, our research has taken multiple in-depth looks at the exogenous drivers of what we think of as “alpha availability” among active managers. Our original work focused on smaller AUM managers’ ability to deliver relatively higher levels of alpha in various market environments (“Survival of the Nimble”). In early 2013 we expanded our analysis to identify active manager alpha drivers across markets and through time (“Is Active Equity Management Alpha on Permanent or Temporary Disability”). Building on our prior work, this study looks more in-depth at the concept of alpha availability (Part 1). We analyze the drivers of alpha availability with advanced techniques and higher resolution data (Part 2). Finally, we take a top-down look at the differences in quantitative managers’ return pattern vs. their fundamental peers (Part 3), which our colleagues wrote about earlier this year (“A Challenging Environment for Quant Strategies”).

Note to reader: Our use of the term “manager” represents the collective investment decision-making mechanisms of an investment strategy or portfolio. It includes the investment staff, systems, and quantitative models employed.

Key Takeaways from This Analysis:

• High Active share is a necessary, but not sufficient condition for high levels of excess return. Active share magnifies the skill (or lack thereof) of the manager. The availability of alpha due to market conditions will have the largest impact on highly active managers.
• The ideal market for active managers isn’t simply a bear market. In developed markets, active strategies perform best when there is concentrated weakness in benchmarks (a heavily weighted concentration in stocks lagging the index). This is almost always true in bear markets, but it is also common in the early cycle market rebounds.
• Periods of large, concentrated benchmark weakness are infrequent and difficult to predict. More actionable factors that coincide with high levels of alpha availability are a low to moderate liquidity environment, moderate levels of factor skew, low correlations amongst stocks and well-defined expectations for economic policy.
• The drivers of alpha availability are unique to the markets they operate in as well as the investment approach. There are distinct factors which benefit quantitative managers over fundamental managers and vice versa.

Part 3

Alpha Availability Based on Investment Approach

In Part 2 of our study, we uncovered the systematic factors driving alpha availability across regions. Our experience as allocators tells us that a manager’s investment approach is also an essential factor in understanding the availability of alpha for a strategy.

Fundamental and Quantitative approaches are very broad categorizations that delineate the strategy of a manager based on the use of quantitative models in the selection of investments. The reality is that almost all managers use some level of quantitative modeling in their process. Even the “old school” fundamental stock picker will often use a quantitative screen to help cull their universe to a manageable level or use statistical risk models during portfolio construction. When evaluating a manager, we consider a pure quantitative manager as someone who systematically selects stocks and builds portfolios without human intervention. In practice, very few managers are ‘pure’ quants, and live in the shades of gray between the extremes. For purposes of this analysis, we utilize the “primary investment approach”, which managers have reported to Evestment. We combine “Quantitative” and “Combined” approaches. Based on our knowledge of the managers, most managers listing “Combined” are heavily skewed toward systematic implementation.

As we analyze these 2 approaches, it is important to note that this analysis is not trying to opine on their relative merits. We are analyzing the common traits portfolios using the same approach tend to share and what that means for when they will most successful generating excess return.

Jump to Section

Alpha Availability Based on Investment Approach | Page 2
Analysis | Page 4
Summary of Analysis | Page 6
Actionable Takeaways | Page 7
Appendix | Page 7