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Is generating Alpha realist enough for fund managers in Namibia?

Is generating Alpha realist enough for fund managers in Namibia?

By Arney Tjaronda
Equity Research Analyst & CFA Candidate).

Investment professionals would argue with me on this topic and it is understandable, however, research depicts that there is a certain level of confidence that this article could be airing out dirty (or clean) laundry that many people- including clients- are not cognizant about.

Generating alpha in finance is a process of generating absolute returns, based on the performance of the classification of securities such as; equities, fixed income securities, derivatives, money market, and real estate. It assumes a higher performance of a portfolio manager while taking into account the same risk factors.

The term alpha was first used by Michael Jensen from the Capital Asset Pricing Model which posits that the expected return of a portfolio is equal to the base rate of return plus compensation for the risk of the portfolio. It goes without saying that upon retirement, Namibians are often in search of opportunities on where to invest their pensions payouts, so they turn to investment managers who seem to know what they are doing in terms of generating alpha.

I assume they do not concern themselves with the type of investment strategies employed to generate alpha, besides the performance of the manager and the risk status of the portfolio. The current macro-economic environment has disrupted the majority, if not, all of the asset classes to the extent where the MSCI All Country World Index and the FTSE World Government Bond Index pose annualized returns of -17.05% (YTD) and 16.31% (YTD), respectively.

Mainstream investment funds were crucially affected by this which made most of them underperform the benchmark, ultimately affecting portfolio managers in producing alpha for their clients. In many cases, clients need to understand that investment professionals just don’t consistently produce alpha over time.

Their ability to produce alpha is affected by events like the Covid-19 pandemic, the Russian-Ukraine war, the global energy crisis, and other factors that suppress the economic environment, making several asset classes difficult to yield attractive ROIC. However, this does not take away from the fact that some investment professionals can produce a lot of alpha in certain market conditions, irrespective of the magnitude of the fund they manage.

It is believed that generating alpha, especially from most large scalable funds or strategies is a zero-sum game, that is why the majority of funds are not focused on outperforming the market, but rather on diverging their resources to increase their client’s wealth at a consistent pace.

The actual producers of alpha are those funds that are closed-off to the public (they are called closed-end mutual funds). These funds perform remarkably well because they appear to possess a “secret formula” on how to produce “pure alpha” for their clients. There is an old logic that goes without saying, “if you have found a way to make money, why would you give away 70% or 80% of it?” That logic applies to this business case too, hence why funds like Bridgewater Associates and Renaissance are closed-off to public investors.

Those funds do not need external capital as they are already accumulating millions (if not billions) from their alpha generating strategies aka “secret formula”. I am not saying that open-end funds do not produce alpha. Open-end funds do produce alpha specifically on buying on the bid and selling on the offer, which gives them a statistical and measurable advantage.

Producing alpha while outperforming the market is measured by benchmarks. Benchmarks are used by some clients to express relative risk objectives, which relate risk relative to one or more benchmarks perceived to represent appropriate risk standards.

Recently, benchmarks have been under scrutiny by various asset managers in South Africa blaming unit trust managers for using “self-serving benchmarks” to rip off huge performance fees from clients, even when losing their investor’s money. Unfortunately, there will be time to debate on such claims in my next publication.

Lastly, since many fund managers in Namibia are risk averse (moderate to low risk) with massive capital preservation portfolios, they are focused on producing alpha constantly over the long-term investment horizon.

Thus, making generating alpha as realistic and pure as it can be for fund managers in Namibia. But hey, this is nothing but one man’s opinion.


 

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