The theoretical significance of alpha within the investment jargon is simply a gauge of performance against a benchmark. Simply put, alpha is the excess return of an investment vehicle relative to the return of a benchmark.
Alpha is usually generated through what we call active management, whereby the investment professional is actively re-adjusting the portfolio weights when compared to those of a benchmark.
If the manager believes that a particular exposure will outperform in the coming quarter, s/he will increase the exposure more than that of the benchmark, in which case we would say the manager is ‘overweight’ the benchmark in that particular sector.
On the contrary, passive management is an investment style, which tends to mimic a particular benchmark in terms of weightings. The said investment style is predominantly associated with what we call ‘exchange-traded funds (funds), whereby such investment vehicles are re-balanced, usually quarterly, in line with the re-balancing of the comparable benchmark strategy.
Today, many market participants believe that due to technological advances, and thus due to the rapid stream of information, the generation of alpha is difficult to achieve primarily in developed markets. This ties down to primarily what we call the ‘semi-strong form efficiency’ theory found in the investment world, which implies that public information, such as a company’s fundamentals are already being factored in the price of the instrument. That said this is highly debatable given the fact that a good investment professional which is continuously seeking relative value, will ultimately generate an excess return.
On the contrary, to date there is still consensus amongst market participants that within the emerging market (EM) world, the possibility of generating a higher alpha is still possible. The said preposition is based on the fact that selective EM regions will hold material and non-material information which seems to be one of the catalysts for the higher alpha close to their chest. Indeed the said higher alpha might be captured by one of the disadvantages which EM countries are consistently criticised for – the lack of corporate governance. One factual example, which comes to mind, is the lack of information disclosures to the public.
In my experience in analysing EM regions, the relationship aspect is imperative to capture the excess return by reacting prior other market participants. In this regard, a direct contact with the company’s investor relations department is imperative. This will help ensure that the dissemination of information is received in a timely manner for an investment manager to react accordingly.
In addition, the informal relationship with both the company and other market participants involved is also important in collecting public, non-public and non-material information. This is what we call in the investment world the ‘Mosaic Theory’. Such gathering of information will help the manager in forming an opinion of the possible upcoming events, which will affect the value of the security in question.
The above are only few examples of how excess return is usually generated by EM Investment Managers. Bizarrely speaking, the disadvantages seen by investors within the EM world can be seen by Investment professionals as opportunities to generate the abnormal returns over a particular benchmark.
Thus, the threats of the lack of corporate governance, corruptions scandals and other events that trigger a movement in an asset price are possible opportunities to go overweight/underweight the benchmark and generate alpha. Through experience, indeed, these opportunities are still available. Don’t shy away, trust your investment professional to generate alpha.
Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.