There was more evidence last week that alpha-centric investing is rebranding itself.  Clearly alarmed about the negative imagery now associated with the term “hedge fund”, several alternative asset managers have adopted the moniker “absolute return” or have simply dropped any reference to alternative investments from their name.

One good example is the rebranding last week of Chicago’s Harris Alternatives LLC.  The firm adopted the name of its flagship fund, calling itself Aurora Investment Management since “Chicago already has too many Harrises“.

But notice another subtle change.  The firm also dropped the “Alternatives” bit in favor of the more traditional “Investment Management”.  In reference to investors’ habit of referring to Harris as “Aurora” all along, Pensions & Investments saw this as a case of “if you can’t beat ‘em, join ‘em.” But that observation also clearly applies to the firm’s decision to position itself as a provider of traditional investments – not just alternatives. (In fairness, Aurora’s home page makes it clear that the firm is still solidly in the alternative asset management business.)

Aurora isn’t alone.  Bridgewater Associates was recently crowned by Fortune Magazine as “The World’s Biggest Hedge Fund Manager”.  Yet despite this achievement, Fortune reports that Bridgewater “doesn’t use a lot of borrowed money” and that Dalio “hates being called a hedge fund manager.” (Though oddly, Fortune also says Bridgewater’s leverage ratio is 4:1, higher than the hedge fund industry average.)

Meanwhile, traditional investment managers continue to launch sorties into alternative territory.  More and more traditional UK asset managers are apparently adopting the “absolute return” moniker in effort to expand their product offerings.  As P&I also points out in this article:

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Axing investment managers is nothing new for institutional investors.  So initially we didn’t see anything particularly interesting about this story in P&I about how the pension fund for Massachusetts teachers and public employees was dumping a few of its underperforming managers.

But when we took a closer look, it was apparent that something else was at play here.  P&I reports that this move was actually a “strategic shift in the $50.6 billion system’s domestic equity program to index funds and portable alpha”. In other words: a shift out of traditional “pre-packaged” alpha and beta and into a bifurcated alpha/beta program.

A third of the freed-up capital was immediately reallocated to three portable alpha managers and two-thirds was destined for an index fund.

But the story gets even more interesting.  Bridgewater, a company we applauded for not messing around when it came to portable alpha, was actually fired in the shake-up.  Why?  Remember a couple of years ago when we told you about the firm’s plan to drop clients that didn’t want to move to a portable alpha strategy?  Well, apparently, Mass PRIM let them do just that.  According to P&I, the pension said “no way” to a pure alpha mandate and it promptly showed Bridgewater the door…

“Bridgewater Associates, which ran $591 million in global inflation-linked bonds, including an allocation to commodities via swaps, was terminated after the board rejected its request to change the portfolio to a pure alpha strategy. Bridgewater’s offer to wind it down over the coming 12 months was turned down; Mr. Mavromates said PRIM decided it didn’t want someone who wasn’t interested in managing the strategy over the long term to look after it for the coming year.”

It appears Bridgewater’s Ray Dalio wasn’t kidding.

Ray Dalio

President and Chief Investment Officer of Bridgewater Associates (manages $170 billion, $30 billion+ in its “Pure Alpha” hedge fund strategy).

Bridgewater Associates
Interview (Derivatives Strategy)
Relevant Postings (AllAboutAlpha.com)

Bridgewater CEO Ray Dalio was in the news again last week with this New York Times story on his concerns over the “high correlation” between hedge funds and the S&P500 during the past few years.  (Hat-tip to Greg Newton of Naked Shorts for the heads-up as we were “WiFi-ing” around Canada last week).

Hedge fund replication researchers say that the heterogeneity of hedge fund strategies is diluted when hedge funds are analyzed as one aggregate mass.  They say that, overall, hedge funds can be replicated (or at least approximated) by the S&P 500.  However, they also say that sub-strategies are far more difficult to replicate using a simple long position in any broad equity index.

According The Times, Dalio essentially says the same thing in a recent private letter to investors - that hedge funds, overall, have a relatively high correlation to the S&P 500.  (But at 0.6-ish range, not nearly as high as mutual funds).  On an individual substrategy level, Dalio points the finger at long/short equity (0.84 correlation to the S&P 500 over the past 24 months).  But the Times makes no mention of the correlation between other strategies and the market (e.g. market neutral).

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As regular readers will know, we’ve used the somewhat esoteric term “alpha-centric” to describe everything from portable alpha to 1X0/X0 on this website.  Sure, it’s a bit awkward, but ”portable alpha” is just one strategy that is enabled by explicitly identifying and manipulating the various embedded components of actively-managed funds (either long-only or hedge funds).

We used the term to describe Bridgewater Associates, one of firms on the vanguard of alpha-centric investing, when they asked their clients to switch to portable alpha last October:

“Like us at AllAboutAlpha.com, CEO Ray Dalio believes alpha-centric investing represents a fundamental re-organization of the investment industry.”

Despite raising the warning flag about hedge fund leverage, Dalio himself also used the term “alpha-centric” recently to describe Bridgewater’s philosophie de la vie.  As Money Management, an Australian magazine, reported a couple of weeks ago:

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As regular readers know, we are big fans of Bridgewater Associates. Their quintessentially “alpha-centric” view of the world amounts to a case study in modern portoflio management. The firm put out an interesting note in January that was recently brought to our attention by blog wonderkid Yaser Anwar over at investmentideas.blogspot.com.

The following excerpt succinctly sums up the philosophy shared by $100b+ Bridgewater and the somewhat smaller, but no less enthusiastic, AllAboutAlpha.com:

“As you know, we generally view the move into hedge funds as part of the evolution of money management. As we have described for many years now, the investment world should, and will, evolve towards a world of separating passive investment decisions (we call them beta) from active investment decisions (alpha). Most institutional investors continue to tie together their alpha and beta decisions (i.e. an institution typically decides how much money they want in equities and then goes out and hires equity managers to manage it). This is clearly inefficient, as the two decisions need not be linked.”

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“Engineering Targeted Returns and Risks”

By: Ray Dalio, Bridgewater Associates
Published: December 31, 2005

As regular readers may recall, Alpha Male was at a hedge fund conference last fall involving a large number of institutional investors.  While the “main stream media” was not invited, AllAboutAlpha.com was able to report on a few general themes and some of the extra-curricular events.  One of the speakers was Robert Zink of behemoth money manager Bridgewater Associates, managers of over $150 billion in AUM (and pioneers of alpha-centric investing).  He brought with him a very interesting message, but we ran out of space and time to report on it back in October.

Thankfully, a loyal reader just passed along this article by Zink’s boss Ray Dalio (CEO & founder of Bridgewater and super-rich guy) and reminded us to post on these issues.  In the article, Dalio makes essentially the same arguments as Zink did last fall - that any asset class can be levered or de-levered to assume any level of risk.  Dalio also claims that alpha-centric investing will cause the lines between “hedge funds”, “long-only equity” and all other asset classes will melt away as all asset managers fight for “the whole enchilada“.

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By: Vince Calio, Pensions & Investments
Published: October 30, 2006

Okay, so not everyone is a huge fan of portable alpha.  Can you blame them after all the hype?

But as the recent Goldman Sachs Annual client pow-wow illustrates, there remains much debate over basic definitions.  According to Pensions & Investments, endowments are particularly skeptical of portable alpha.  They argue that their long time horizons and lack of liquidity requirements mean they can plough all they want into pure alpha strategies without concern for back-filling the beta:

“‘Actually, one of the first things we did when I got here a year ago was to get rid of our portable alpha manager,’ said David Russ, chief investment officer of the $3 billion endowment fund of Dartmouth College…’Our job is to control costs and look for alpha. We don’t have the liquidity requirements of a pension plan and therefore, we can afford to make direct investments in the higher returning asset classes.’ He declined to name the manager.

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By: Christine Williamson, Pensions & Investments
Published: October 30, 2006
   
Talk about industry leadership.  According to Pensions & Investments, Bridgewater (manager of $165 billion) has sent letters to its clients saying that portable alpha strategies are such a no-brainer, that any client not buying in to the approach in the next 12 months will be, as P&I puts it, ”resigned”.

“Raymond T. Dalio, founder, president and co-chief investment officer of the Westport, Conn., firm, said Bridgewater has been sending letters about the firm’s portable alpha focus to clients now using what he called ‘constrained’ or ‘undiversified’ mandates, which don’t permit Bridgewater to freely move among asset classes. Those letters not only encourage clients to move their assets to portable alpha approaches, but also contain very gently phrased notices that accounts of clients unwilling to make the transfer will be resigned within 12 months.”

Letter recipients reportedly included:

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By: Ray Dalio, Bridgewater Associates
Published: June 2006 

Excerpt:

“Properly executed, alpha overlay leads to better investment results with no more risk than traditional investment management for the following reasons: 

1. The total return of a portfolio equals the return of the asset classes invested in and the managers’ alpha; this is equally true if the alpha produced is in the same markets as the asset class or in other markets. As a result, a portfolio constructed by independently choosing the asset class (beta) and the alpha is no more risky than one managed by following the traditional approach (ie, with alphas coming from the same markets as the betas);
2. However, choosing alphas from wherever they are best obtained and through creating a much more diversified portfolio of alphas, a properly executed alpha overlay strategy can produce much better risk-adjusted alphas; Alpha overlay managers can attach their overlay portfolio to virtually any asset class. This allows investors to generate attractive alpha in asset classes that are otherwise difficult to generate alpha in;
3. The risk-adjusted alpha can be easily calibrated to coincide with each investor’s specific risk tolerances.
4. So, with the new paradigm, investors specify the betas they want, independently choose their alphas and tell their managers how aggressively to run the alphas.”

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