July 12, 2023

Chasing Beta

Does alpha exist? 

That was how a hedge-fund executive began a conversation when I was in his office back before the pandemic.  He said the joke among hedge funds is that everybody is pursuing something – higher risk-adjusted returns – that might in fact not exist.

I shared with you readers of the Market Structure Map what Apollo CEO Marc Rowan said.  Alpha doesn’t exist in

Photo 37776647 | Beta © Adonis1969 | Dreamstime.com

public equities, he said. Over 90% of stock-pickers don’t beat the benchmark, and you can buy beta for six points.

Let’s cut through the jargon.  Alpha isn’t just the first letter of the Greek alphabet. It’s the capital-markets term meaning beating the benchmark.  Taking the same risk as the market but achieving a higher return (thus “risk-adjusted return”).

Beta is the market’s movement. What Rowan meant about buying it for six basis points is that you can own an S&P 500 ETF that delivers beta, the market’s return, for six basis points from Blackrock, Vanguard, State Street.

Well.

Set aside what that means from an investment standpoint.

And by the way, there is alpha.  In private business (thus the explosion in private equity).  In real estate (not all of it, but the Mark Twain adage about buying dirt because they ain’t making more of it still holds). In short-term trading (Citadel, Renaissance Technologies, Susquehanna, Quantlab, Jane Street, Two Sigma, Hudson River Trading, etc.).

Consider what the absence of alpha means to public companies.  Mathematically, stocks have less than a 1% chance of becoming alpha – beaters of the benchmark.

Yet 100% of management effort and investor-relations action is predicated on targeting, attracting investment flows to a superior investment.  The odds are worse than Las Vegas.  Worse than a slot machine in a gas station on an Indian reservation.

So why not flip the tables and take house odds?

If the market wants beta, give it beta.   You have a 99% chance of succeeding, public companies. If you show up, you’re virtually guaranteed achievement. IR pros, rather than targeting an audience fighting outflows – stock-pickers lose about $500 billion per year to Blackrock, Vanguard, State Street, private equity, bitcoin, etc. – why not focus on your characteristics that make you beta rather than an extremely unlikely alpha?

Yes, some companies will blow the doors off with catalysts.  But unless you’ve got one, you’re Sisyphus rolling a stone uphill. 

And we’ve got a fabulous opportunity to reinvent IR for a beta market. Especially you young practitioners.  Earnings releases?  Make them short, general and weighted toward your characteristics.  Same with earnings calls.

We are spending too much time creating data and information for a target audience that’s been trounced by beta.

Look.  Sellside analysts don’t pack much weight anymore. In 1995, you were courting royalty on the sellside. Now it’s more the jester.  JP Morgan said years ago that less than 10% of its trading-desk flow was stock-picking. They’re now one of the largest global money managers and they run asset-allocation models.

Learn by observation.

What about JPM’s wildly successful active ETFs, JEPI/JEPQ? Active ETFs aren’t picking stocks. They’re using human discretion to find a woefully scant PRODUCT called stocks that can back the ETF.

We’re in the data business. We know this stuff. Our model for a risk-hedged Momentum portfolio produced a 37.2% return Jan-3-Jun 30 this year.  The trouble is a paltry collection of stocks meet the criteria.

Back to our narrative, money buys equities as products. Not stories.  The job of IR is to know what the money is doing and how the market consumes shares and provide that data and information to the c-suite. This is vastly superior to braining oneself against the alpha brick wall, and far more strategic.

The job of the c-suite is to deploy shareholder-capital to deliver beta.  Not alpha.  If the market wants a growth product, give them one.  If it’s value, give them that.  Vastly more strategic and controllable than the odds you’ll have a catalyst.

Earnings calls were invented because over 90% of investment assets were actively managed and market volume tied back to superior fundamentals.

That market does not exist.

Now, less than 40% of institutional assets are actively picking stocks, and less than 10% of market volume is buy-and-hold money.

The grand frontier for public companies is rethinking how we interact with beta. And it’s pretty darned simple.  Characteristics.  Know what the money is buying in your stock, and deploy shareholder resources to create more of it.

Because all the information is already known anyway.  And it’s not what motivates money.  Money is motivated by size and liquidity. Because that’s what counts in a beta market.

If you want to know more, ask me.  We have a game plan for success in a beta market.

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