LESSONS FROM THE BUY AND SELL SIDE, CHASING ALPHA IN PUBLIC AND PRIVATE MARKETS, INDEXING EVERYTHING?
Over the coming months, I’m going to write about the productivity benefits of AI, but so far, my most valuable insight from a few weeks of conversations across market participants, is in the growth of the buy side, use cases for public / private markets and how to chase alpha over indices…
Early lessons – chasing alpha in public and private markets:
Learning how to trade public markets is not easy. Translating mathematical models into market profits on an intra day basis…well, markets are a zero-sum game outside the rising tide of beta, and markets have people in them, who are indeed irrational.
If you can get yourself space on a desk with real money flows that helps, having access to client flows with margin gives confidence to take positions on reserve bank rate decisions, which at least I still regularly and painfully got wrong, sometimes for months on end…and all traders claim the end of year PNL is skill over flow …
Discounting cash flows is necessary but not sufficient. Yes, you can improve the value of companies with clever business and financing strategies. Thorough due diligence and well executed 100 day turnaround plans can and do work to create alpha. But it takes an investment of time and money, with many 20 something MBAs catching flights and late nights.
Looking at the recent example of Virgin Australia, was it worthwhile Bain buying and turning around? Yes. Will buyers of the IPO at at 30% discount to the Qantas multiples do well? Again Yes. Did the IPO only work at a public discount to private value because Bain had already taken profit?
Does every single deal, every fund, every private manager provide value…Are investors compensated for the lack of transparency, leverage, suppressed volatility and illiquidity risk?
Hmm…
Later lessons – Index everything:
MSCI provided an immediate lesson in the value of a good IPO. Taking MSCI out of Morgan Stanley allowed the public markets to value this hidden gem at a subscription revenue multiple opposed to trading PNL. This allowed MSCI to buy Risk Metrics and serve all sides of the market with both data and analytics. Personally, buying into this company and the IPO was probably one of the most successful trades I have ever made.
Index makers, like the University of Chicago economics theories, run on the basis that beta should be delivered at the lowest possible price and investors should only pay up for real alpha…large funds and asset owners can find alpha if they can access the best managers and monitor / track performance to ensure they get what they are paying for.
Are there problems with cheap beta? For sure, Index theory stops working if the whole market is indexed, small stocks are ignored and the line in and out of the largest indices becomes a barrier to capital, of course MSCI made small cap indices to compensate, but do people use them?
Another index issue, IPOs must be “seasoned” with sufficient public trading. Including them immediately in the index means you reliably believe they will be large enough to qualify, requires knowing a market value and obliging index trackers to buy the IPO and reweight constantly as the offer price fluctuates, which is not sensible.
Are index trackers missing value if they don’t include IPOs? Yes. MSCI made an IPO index to capture that value, but does any single market participant have open access to all IPOs at a reasonable price? So, has the rise in passive tracking caused a dislocation between private valuations and the ability to offer IPOs? Perhaps
Can you create a cheaper version of beta for what is sold by managers as alpha? MSCI tried and failed to make hedge fund indices with an ETF listed in Europe and later launched private equity / capital indices and analytics. More recently Larry Fink at Blackrock bought Prequin with the same aim. But again, is there open access to the best private funds data? How good is this data? Is there a free flow of capital required to create a tracking fund? MSCI found that the funds that will allow you to index their returns and access the funds are not the best performers and can provide misleading data for a time…
So the lesson appears to be, per the recent discussion paper and submissions to ASIC on public and private markets, all markets are valuable. Having functioning markets is good for both investors and users of capital. While there is a lot of complexity around transparency, risk and returns of public vs private markets, and they don’t always function perfectly at the cross overs, its worth doing our best to make sure that all markets function in the ways they are supposed to.
What this means for Executive Search:
If you are still with me, I hope it is obvious that I am a proud supporter of low-cost beta and true alpha.
Is it possible to get low-cost beta in your hiring practices? Yes, technology means you can access more potential candidates. Put out an advert yourself and run it off the side of your desk if you can. If the role can be adequately filled by a large number of suitable candidates that are actively looking in the market, then manage your investor and shareholder costs and take the low-cost beta.
Does alpha exist? Also yes. Some roles provide a high risk / reward to your business and need the time and attention to choose carefully, with a high validation of candidates’ qualifications and strategic / cultural fit. The top candidates are usually not looking or need to be persuaded to listen to a pitch on why your role is ideal for them.
Can you replicate the alpha of external search yourself? Not exactly. You may have a large enough business to build out quasi search and succession planning capabilities internally. Just know for key roles, where market discretion is required, you may be missing the benefits of anonymity, plus the third-party persuasion factor. There are also opportunity costs in missing the best candidate for the role that can be greater than the short-term saving.
Can Blenheim, and I, provide you alpha? Resoundingly YES. I joined Blenheim because I believe in the quality of their service. With a 100% success rate and 70% of candidates still in role/company after 5 years, we will find you the perfect candidate, who wants to work with you and matches your strategy and culture. With my background across various parts of financial services, I will be able to understand the intricacies of your strategy and the background of the candidate to ensure the perfect fit.
So – if you want low-cost beta, take it, with our blessing. If your role is on the buy or sell side, requires true alpha, you want a partner who can and will go the extra mile to deliver, please call Blenheim.
Julia Patterson
Partner, Financial Services