When Beta’s All That’s Left: Kang

It told a lot, interspersed with a fair amount of gloom. Pointing to a chart that overlays the performance of the S&P 500 from its historic peak onto the performance of the Tokyo Stock Exchange since its peak a decade earlier, he suggests: “There’s a chart right there that should tell you that maybe it’s not a bad idea to leave this industry. And certainly, when you look at fund flows out of mutual funds into something like ETFs, that’s a pretty good reason why.”

His chief thesis is that “we probably don’t live in an era of bull markets any more over long-term periods. I’m not going to forecast that. It may not be that kind of world. Certainly it didn’t work for much for Japan – quantitative easing and ZIRP (zero interest rate policy) –  so why would it work for the U.S? There’s no guarantee.”

Fleshing out that thesis, he questions a buy and hold strategy, and more.  “Maybe an equity risk premium of anything beyond anything between zero and 2% is questionable,” As a  result, “maybe some kind of active management is the way to go.”

But it’s not traditional alpha-seeking active management.

“We’ve moved from stock-picking to the 1980s to mutual fund manager selection and we know that mutual fund investors underperform the mutual fund return itself. The mutual fund companies say, ‘please don’t trade our stuff because it hurts their bottom line.’ That’s part of the reason why it’s moving over into ETFs because ETFs say, ‘please trade our stuff because when you trade frankly our stuff it gets shown on the ticker and that’s the best advertisement in the world, right, because the liquidity is there’.”

His solution is “something that we might call beta-tilting or beta-timing.” But of course, that involves trading – the bane of advocates of passive buying and holding.

“The question is: is that good for you? So now I’m an ETF guy and I’m pushing a product and there’s evidence that says that trading is detrimental to your health.  Does that make me a crack dealer, essentially? I honestly don’t think so. I don’t want to tell my kids that I’m a crack dealer.”

For most investors, alpha isn’t available. Instead, it’s matter of choosing which markets to be active in and which ones to be passive in.

“You go to the CalPERS website and they’ll tell you the asset allocation as such and how much of a percentage is active and passive. Not a bad idea. If you are Yale, then you can be active and pick private equity if you can handle that illiquidity risk. There are certain risks that you want to take. There are certain risks that you don’t want to take. There are certain risks that you will regret later. ‘Give me back my money.’ Gate goes up. ‘Too bad you guys, that was part of the deal’.”

Moreover, he thinks active management – hedge funds in particular – has oversold its claims. “It’s a risk reducer not a return enhancer. It can only do one of two things. Part of me leaving the hedge fund industry is because we tried to push the idea of being both risk reducer and return enhancer.”

Beta is easier to achieve than alpha, he argues. “We all have this spectrum that we can choose from . The spectrum is the alpha-beta spectrum. Over at one end is pure beta: S&P 500, low cost, pure market risk. At the other end, you’re alpha, right, never mind the statistics and the math, market risk – it’s managers. Think about it that way. What’s the risk over here? The volatility of the market. What’s the risk over there? You invested in Madoff.”

Alpha, he concludes, is rarely accessible until it becomes beta. The difference? “At the beginning I can charge 2 and 20 and later when everyone has it, I charge 7 basis points.”