Barton Waring

Managing director and head of the Client Advisory Group at Barclays Global Investors.  Previously, head of Ibbotson Associates.

Bio (Yale Alumni Association)
Research (SSRN)
Relevant Postings (AllAboutAlpha.com)

We are pleased to bring you a special guest posting today by one of the big names in institutional money management.  But unlike most big names, this one comes from the ranks of investors, not asset managers.  Laurence Siegel (see related posting) is the Director of Research at the Ford Foundation.  He was co-author of a hugely popular article in the spring 2006 edition of the Financial Analysts Journal called “The Myth of The Absolute Return Investor” that took issue with many of the popular assumptions about absolute return investing.  (Siegel’s co-author, BGI’s Barton Waring is featured in a summer 2006 webcast on the topic).  In addition, Siegel was also co-author of a great piece called “Five Myths About Fees“, which originally appeared in the Journal of Portfolio Management.

Siegel is speaking at a conference next week in New York on the topic of alternative beta and hedge fund replication.  In this AllAboutAlpha.com exclusive, he gives us an overview of his thoughts on “exotic beta”. 

Are Exotic Betas Worth Investing In? A Brief Note.

By Laurence Siegel, Special to AllAboutAlpha.com

What are exotic betas?  What are clone funds?  Has the sober science of money management been taken over by aliens from outer space?

No.  Let’s start with a brief (but not brief enough) history lesson.  Hedge funds evolved out of active management, the attempt to beat a benchmark using security holdings weights that differ from those in the benchmark.  Hedge funds differed from traditional actively managed funds in being able to sell short and use leverage; and, typically but not always, in having no fixed mandate (thus no fixed benchmark).  Nevertheless active management, including hedge fund management, is always about beating some sort of neutral or normal portfolio that you would hold in the absence of any views.  That neutral portfolio is the benchmark; if the fund is perfectly hedged to all systematic market factors, then there is still a benchmark, but it’s cash.

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Looks like BoNY M will have to update its list of trillionaires.  Number one UBS ($2.016t) is being trumped by Barclay’s / ABN AMRO ($2.058t).  But the difference is “razor thin” at a mere $42 billion (a tad larger than the GDP of Kenya for those keeping score at home).

While it’s nice to manage more assets than the GDP of the UK itself, some analysts are suggesting that Barclays isn’t actually that interested in ABN AMRO’s asset management business at all.  One banker who asked not to be identified told Pensions & Investments yesterday:

“It’s not a great fit…BGI is passive and quantitative, while ABN AMRO is active fundamental. Picking up ABN AMRO’s business doesn’t do much for what BGI is trying to do.”

As regular readers know, we’re not equity analysts.  And we have no inside information to share with you on this.  But we don’t think Barclays should be so quick to dump ABN AMRO’s asset management business just because it’s “active”.

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The Right Answer to the Wrong Question: Identifying Superior Active Portfolio Management

By: W.V. Harlow, Fidelity Research Institute & Keith Brown, University of Texas
Published: Fourth Quarter 2006, Journal of Investment Management

The search for alternative beta aims to explain some of the unexplained magic and mystery behind hedge fund management.  Once we strip these betas from a hedge fund’s return stream, we often conclude that average hedge fund doesn’t have enough alpha left over to justify its fees.  Sure, some funds beat their benchmarks.  But on average, many say, managers produce no alpha - or worse yet – negative alpha.

But do you need to invest in the average hedge fund (or actively managed mutual fund)?  What if you were better than average at picking good managers?  In this study, Harlow and Brown say we shouldn’t get obsessed with the ”average” mutual fund manager.  Instead we should simply find “good” managers.  They call focusing on the average mutual fund a straw-man argument – chosen by indexers because it’s easy to refute:

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By: Barton Waring, Barclays Global Investors & Laurence Siegel, The Ford Foundation
Published: June 2005, Journal of Investing

This is an excellent article that debunks several time-honuored marketing pitches used by active managers – and by extension hedge fund managers.  Waring & Siegel say: 

“We strongly believe that in the presence of skill active management can be successful. But we also believe it can be sold on its own merits without artificial arguments. So here we debunk some of the myths and stories often told in support of active management. We fear they do more harm than good, and sow confusion, misunderstanding, and ultimately distrust of healthy management disciplines.”

Waring and Siegel argue that many (most) active managers don’t properly understand the extent to which their returns are driven by beta.  

“Good managers know the difference between true alpha and market returns. And they know that active management is a zero-sum game…”

While uncorrelated “absolute” returns are often touted as the ultimate in active management, the authors argue that reducing beta exposure can actually be a bad thing if it confounds the client’s policy mix.  In other words, there is often method in the madness of a high beta exposure. (Still, there may not be method in the fees charged by active managers for beta exposure that can be purchased separately for close to 0%).

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By: Baton Waring, Barclays Global Investors

Excerpts: 

“Every portfolio has a beta component and an alpha component. In the sense that beta really is about benchmarks that represent market returns, all investing is benchmark relative investing! This is unavoidable. The protests from traditionalists notwithstanding, any and every portfolio can be and should be thought of as some combination of beta and alpha, and the obvious and useful consequence is that all investments must and should be done on a benchmark-relative basis. This should not be protested but embraced, and it is embraced by the best and most modern active managers and plan sponsors.

“Here is the important distinction: Alpha, on the other hand, is only conditionally  rewarded, and therefore, the expected alpha return is only conditionally different from its normal or unconditional expected return, which means that it will have a return of only zero percent! From the efficient market hypothesis, the unconditional expectancy for alpha is zero because the markets tend toward efficiency. The markets are a zero-sum game—a negative-sum game after fees and costs.

“Under what conditions is alpha different from zero? The conditions that allow a positive expected alpha that are still consistent with modern portfolio theory are (1) some degree of inefficiency in the market plus (2) some extraordinary or above-average level of skill. Both factors must be present for the investor to have a positive expected alpha. The important conclusion is that, although we have to recognize that having a true expected alpha is one of the hardest things in finance (and, in fact, across all investors the average expected alpha must be zero), for the most skilled, a positive expected alpha can indeed exist.”

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