Green Day on Broadway
The influence of alternative ideas and approaches constantly redirect and reinvent the mainstream. Innovations first introduced outside of the mainstream and, in many cases, defined as counter to it, become broadly adopted and eventually accepted as mainstream themselves.
This is not only the case in the asset management industry – it is a broad social phenomena. Take for example the music band ‘Green Day’. Does it make sense to call their music ‘alternative’ anymore? Though once deemed a punk band, against the grain and counter to the mainstream, they are now a defining aspect of the core of contemporary music. Their music is certainly unique. It is precisely this factor that makes it so influential to the mainstream. It is not simply absorbed but has a strong and lasting impact on what the mainstream is. The tourists lined up to see the Broadway show in New York based on the band’s music certainly suggest this.*
When ideas have pragmatic and commercial value, they take root and spread. What works best, eventually works for most. If there is a true innovation that helps to produce better results, provide more predictability and is commercially valuable, it will eventually be adopted broadly. Though, it must be stated, such innovations quite often come to market in versions “modified for general use” and often on a considerable time lag. Watering-down an original investment idea and stripping it of its pragmatic value is a real risk but not a necessity. It is crucial to keep both these points in perspective.
And while we speak extensively about the evolving nature of the mainstream areas of investing due to the influx of new investment ideas and demands from investors, those asset classes and strategies that had been regarded as alternative over the last decade have also matured and evolved themselves. They are not the same as they were ‘pre-most-recent-crisis’ much less ten years ago. New alternative areas of investment and techniques are being developed. The more mature, transparent and easily implementable alternative strategies are readily being adapted for the mainstream. It demonstrates the importance of innovation to our industry – particularly during periods of market flux.
There are a complex group of factors driving this “main-streaming”: a combination of both pulls and pushes from traditional and alternative asset management industry players. Some main drivers include:
1. Direct adaptation of aspects of what had been considered alternative investment instruments and approaches into the mainstream (although not necessarily by the original purveyors thereof),
2. M&A and new product development across the ‘traditional’ and ‘alternative’ divide,
3. Greater attention to and demands for high levels of transparency and categorization within the alternatives industry itself. As the industry matures, risk control and monitoring are becoming primary concerns. The individual strategies that sought to be heterogeneous (unique) and thereby undefinable, get brought together as a group of “like” peers making a homogeneous category. In a strange logical twist, they become less alternative by virtue of being identified and categorized as alternative.
The last point is particularly remarkable. I have watched with great interest the development of various categories for hedge funds – from about seven to twenty-five to a hundred, not entirely different than the climax of “hyper style boxing” of managers in the 1990s-2000s that took place (primarily) in the U.S.
Breaking strategies down prescriptively into geographic and market cap ranges will be the downfall of many good managers regardless of the vehicle in which their strategy is made available to investors.
Of course, categorization starts with the intention of being descriptive. It seeks to answer the questions “what is there and what does it do?” But unlike with scientists developing names and categories for physical elements, flora and fauna, asset management is a human endeavor. In looking at a broad range of managers and seeking to identify common characteristics, analysts and consultants influence the activities of the managers. Not recognized by many players in the space, this process effectively pushes such strategies towards the mainstream through providing higher levels of information and transparency. The managers must keep moving to redefine themselves and stay innovative and/or to fit within the assigned boxes that have been created through an asset allocation process. (I have written extensively about this elsewhere – see the article directly before this one for instance and articles on ‘Sharpe and style’).
There will always be an alternative. I am not suggesting that the investment world has regressed to a homogeneous lump and that there are not investors doing things differently. In fact, let’s hope that in asset management (and in every other field of human endeavor) we have constant innovation. Without innovation and new ideas, our lives would be pretty boring. The point is that the horizon and borders are expanding and become redefined. Over the last ten years, many of the approaches and strategies to investing that were only available to a very limited group of investors have grown rapidly in both popularity and accessibility. Certain asset classes (commodities, emerging markets debt, real estate) in various forms take a central role. Certain strategies (long/short, global macro, increasing benchmark unconstrained and absolute return oriented) have also become of interest to a broader range of investors. So has the way we think about investing – not losing money (not just relative to an index) makes a lot of sense, as does owning assets other than stocks and bonds. Investment vehicles have become more efficient in delivering them.
There are, and always will be, investment strategies and underlying instruments that are esoteric and do not fit into mainstream investment categories – we must increasingly look further to the horizon to find such alternatives. Now, given the ability to offer many strategies previously unavailable in traditional vehicles through UCITS funds, there is a growing gray area of what is and is not “mainstream-able”. Many strategies may be capacity constrained or illiquid. Their risk/reward profiles may be inappropriate. They may be too complex for sales people or investment consultants to explain. Or, and this is quite often the case, the guy who has an “edge” does not want it publicly broadcast and thereby watering down his ability to generate alpha. The manager can charge 2/20 (or the like) to a small group of like-minded investors who are happy to trade a lack of transparency, liquidity and a part of the return for exceptional talent and returns. But exceptional is the exception.
*http://www.greenday.com/site/american_idiot.php (not a fan of musicals myself, I have not seen it).