This may seem bleak, perhaps even ego-deflating. But believe it or not, there are reliable sources of real alpha out there for both managers and asset allocators. The most important thing is to do what others don't, to move against the cyclical flows of fashion. This may seem like simple advice, but few are actually doing it.
Recent studies, including ”Active Share and Mutual Fund Performance” by Antti Petajisto in 2013, reinforce this point. Mr. Petajisto shows that long-only managers who consistently deviate from the benchmark, meaning those with a higher active share, tend to outperform. In fact, he concludes, “the most active stock pickers have been able to add value for their investors, beating their benchmark indexes by about 1.26% a year after all fees and expenses.”
Let's apply this principle to the alternatives space with a recent example. At the end of 2008, in the death throes of the financial crisis, allocators struggled to find strategies that had outperformed. Many flocked to managed futures, which typically excel in periods of high uncertainty. There was a rush to invest. The result? Five years of flat performance.
What managers should have done instead was bought mortgages, the pariah of the crisis. Baskets of mortgages were priced such that, even with further defaults and limited recovery, investors still got the Treasury yield. This was effectively a free option, which numerous managers passed up.
So, where is the alpha? It's wherever human behavioral bias preys strongest. The lesson here is to take risk — you can't expect a manager to outperform and still look like everyone else.
Tim Rudderow is CEO and chief investment officer of Mount Lucas Management Corp., Newtown, Pa.