June 14, 2023

Vanished Alpha

There’s no alpha left in public equities. Hasn’t been for 20 years. 

Nope, not me.  I didn’t say it.

Marc Rowan, CEO and co-founder of Apollo Global Management, a private equity firm with six hundred billion dollars under management said it in an interview June 8 with CNBC’s Andrew Ross Sorkin at the Economic Club of New York.

It was 430a MT when I saw the clip from the day before, and I was about to write the daily Market Desk note for clients at sister company Market Structure EDGE. I’d just turned on CNBC, as is my custom.

Photo 130258385 © Rido | Dreamstime.com

After standing there paralyzed, mouth open, pre-coffee, through the interview, I regained my senses, paused the TV, found my phone, rewound it, and recorded it with my camera.

Sorry, copyright lawyers. It was just for personal use (but I’d like to buy the clip). It runs about two minutes.  I’ll give you the essence.

Sorkin asked him about making money and finding alpha. 

For those wondering why I’m using a Greek word when we’ve been back from Greece for almost three weeks, “alpha” is in addition to the first letter of the Greek alphabet a term meaning investment returns that beat the market (simplifying but follow me here). 

Rowan said 85-93% of active fund managers in bonds and equities don’t outperform the market’s returns.  They don’t deliver alpha.

He said, sure, you can get beta. The market’s return. But he said you can get that for six basis points from the big publicly traded managers (he means Blackrock, State Street).  In other words, the management fee to get what the market gives is, as they say on The Street, six bips.

If you’re paying more than that, you’re wasting money. And this is why active managers struggle to attract flows.  They don’t outperform the stock market.


We’ll come to that, but what I’m writing about here is central to the investor-relations job, to what public companies do to build a shareholder base.  If stock-pickers don’t beat the market, what’s the point of the sellside?  Why go to conferences?  Why target investors?

Look, I’m not opposed to those things.  They’re the orthodoxy of our profession. But we can’t just blindly do what we’ve always done without considering returns on our efforts.

By the way, most of the money is going to Exchange Traded Funds (ETFs). They don’t manage money for anyone but themselves.

The assets in ETFs are not fiduciary. They’re owned by the ETF sponsor. The fee you pay isn’t a management fee. It’s really a licensing fee.  You don’t have an account with the ETF manager.

Ponder that.

Back to Rowan.  He said 60% of the volume in the market is ETFs, and 80% of the volume is in the S&P 500.  Everybody is levered to five growth stocks and the Federal Reserve, he said.  Those five are 25-30% of the entire market.

They float all boats. Or sink them.

How? Why?

Now we’re getting to it.  Stock pickers can’t beat the market because 800 stocks – 500 large caps, three hundred mid-caps – are nearly all the market capitalization. You can’t pay somebody to “find superior companies.”  You can only do that in private equity.

Small caps are 5%. The 1,700 microcaps in the stock market are about 10 basis points of market cap. The probability that any of those become large caps organically is less than 1%.

And because ETFs are arbitrage instruments – market-makers trade them (there are 2,900 ETFs traded in the US market, nearly the same as the 3,500 companies in the Wilshire 5000) against other things purely on price  – a small group of stocks that trade well and have good liquidity become the proxy for the market.

So if an ETF rises, it’s shorted back in line with the underlying basket of stocks.  If the stocks lag, market-makers buy those to bring them in line.  But they leave out stocks with spreads between bids and offers of more than about 15 cents.

No amount of stock-picking prowess overcomes these market-structure facts.

As the stock market has boomed in 2023, it’s not been on booming flows.  Investors withdrew money to start June at the fastest rate since the bank crisis in March.  ETF flows are the weakest since 2019, down by more than half (said the Wall Street Journal and the Investment Company Institute both) from peak Pandemic levels.

So how can the market rise on falling flows? 

Arbitrage. Stocks are products and prices. A tiny handful of firms can trade them – call it 15-20 major market participants – versus five big Tech names (or seven if you like).

So flows become secondary to what a machine will pay.

The trouble with that is it can all go away in a week if just one or two of those market-makers stops trading.

I’m not predicting it.  I’m saying the stock market is a proxy only for ETF prices currently.  Not a gauge of financial conditions, economic prospects, corporate fundamentals or stability.

This is why data is so important to public companies. Issuers are fiduciaries.  If Wall Street is doing a lousy job helping the public and companies understand what’s actually going on in the stock market, we have to do it ourselves.

We have that data.  We can see at all times where the money is.

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