A Scarcity Of Alpha

A couple days ago I talked to two fund managers who earned net returns to investors of over 200% in 2011. In each of the previous two years, they returned over 80%. Most of this outperformance came from shorting US-listed companies based in China. The managers write in their letters that future returns are very likely to decline, since Chinese frauds are more scarce now. They also mention that their portfolio (besides the Chinese fraud shorts) has tracked the market. Not only are these guys smart, they are honest, too.

Another great thematic trade was to go long Apple and short a basket of its competitors (MSFT, NOK, RIMM, MMI, GOOG, HPQ, DELL). I think that this trade has largely played out, too, and future returns won’t be as good.

So how are we supposed to add alpha now? If I can’t add alpha, I don’t want people’s money to manage. That’s just going to piss my investors off and it’s going to make me look bad. What can we do?

Now I can’t even sell decent premiums because volatility has dropped, I honestly don’t think I have any tricks. The money management business is in such a weird state right now. Asset price correlations are really high. Prominent value investors have fallen into disrepute, with some losing over 20% last year. The best performers were flat. Greenlight lost money in the beginning of the year because they shorted, then made it all back because they shorted. Third Point made some good returns in the beginning of the year because they didn’t short much, then they lost it all as the market dropped. Then the market rallied 11% in October and Third Point was flat.

All I can think of is buying assets that aren’t stocks. Given a really flexible mandate, hedge funds might buy farmland. Mike Burry has this trade on. What other assets are mispriced because capital is not ALLOWED to flow into them? I think that’s an important question for money managers.