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The Alternatives Mason: Building Alts Knowledge Brick by Brick | Episode 2 | Better than Alpha Featuring Christopher Schelling
10 Plays1 year ago
Welcome to The Alternatives Mason: Building Alts Knowledge Brick by Brick. Banrion Capital Management uses technology to help independent advisors scale and educate themselves on alternative investments. Since education is such a big piece of the Banrion mission and business, we are excited to kick off this series to dive into the nits and grits of the alternatives space. Episode 2 "Better than Alpha" features alternative investment thought leader and author, Christopher Schelling.
Chris Schelling is an investor, advisor and published author. With degrees in psychology, business, and finance, Chris is an expert at incorporating insights from behavioral finance into investment decision making. He is also currently a contributing columnist for Institutional Investor and has authored over 60 articles on investing. As an institutional investor, Chris has allocated roughly $6 billion and met with over 3,500 managers across hedge funds, real assets, private credit, and private equity funds. Previously, Chris was Chief Investment Strategist of Venturi Private Wealth, Director of Private Equity at the Texas Municipal Retirement System, Deputy Chief Investment Officer at the Kentucky Retirement Systems, and an adjunct Professor of Finance at the University of Kentucky.
In his book "Better than Alpha: Three Steps to Capturing Excess Returns in a Changing World" Chris explains why strategies based on “beating the markets” are doomed to failure and provides a simple three-step framework for making better investment decisions: Behavior (smart thinking), Process (smart habits), Organization (smart governance). He explains why the search for alpha is destined to fail, the major role behavioral finance plays in so much wasted time, effort, and money, and, most important, how to avoid common mistakes and maximize your efforts.
Follow Chris on 𝕏: @schelling_chris
Host Brittany Mason’s diverse background has given her a unique perspective stepping in to the role as Chief of Staff at Banríon Capital. Throughout her career she has embraced challenging projects proving her ability to lead the development and the successful launch of brands. From staffing, branding, and marketing, Brittany has spent the last 20 years working in the fashion and entertainment industry with some of the world’s most iconic brands. This includes but not limited to event management and production for high scale events like the Superbowl, Indianapolis 500, TAO Group, NYFW, Miami Fashion Week, product launches at Salesforce’s Dreamforce, CES, and partnerships with brands such as John Frieda, Eleven Australia, and Valentino.
Her extensive work in the industry motivated Brittany to produce her own events. In 2013 her first directorial project was to spread awareness for Prostate Cancer. This 1 minute campaign video reached 13 million in just a few short weeks. This is when Brittany began producing charity fashion shows and coaching young entrepreneurs under her brand MOXIE Media. In Just one year Brittany worked with approximately 100 thousand students. In 2017 Brittany launched MOXIE Media Productions in Ireland, becoming the Director and license holder of Miss Universe Ireland. Brittany is known for the rebrand and launch of the Universe brand in Ireland and over the course of 5 years built a historical track record for the country that earned several global awards. Miss Universe Ireland became one of the country’s most exclusive and sought out events to attend. In 2019 MOXIE Media gained the right to Miss Indiana USA and Miss Indiana Teen USA making it the first production company in history to participate in the 3 largest competitions year after year; Miss Teen USA, Miss USA, and Miss Universe. Through her work she has shown her commitment to creating career opportuni
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Transcript
Introduction to Alternatives Mason Podcast
00:00:00
Speaker
Welcome to the Alternatives Mason podcast with host Brittany Mason, Chief of Staff at Bonner & Capital Management. You'll learn how to build alternatives knowledge brick by brick. Bonner & Capital Management uses technology to help independent advisors scale and educate themselves on alternative investments. And since education is such a big piece of what we do, we are excited to kick off the series to dive into the myths and myths of the alternative space.
00:00:27
Speaker
Hi everyone, I'm Brittany Mason. I am Chief of Staff at Bannering Capital and you are tuning into the alternatives Mason on campus though too. I am so excited today because we have a very special guest. A little bit before we get into that though, Bannering Capital, we have special technology where we want to
00:00:46
Speaker
help our advisors scale and grow your business and also offer some educational aspects as well for the alternative space. So I'm so excited for everyone to join in and learn with me. And so please welcome our second guest for episode two, Chris Schelling. Thank you so much for joining us today, Chris. Absolutely. Thanks for having me, Britt. Excited to be here.
00:01:12
Speaker
Thanks so much. So let's go ahead and just jump right in.
Chris Schelling's Investment Experience
00:01:16
Speaker
So can you give us a brief overview of your experience in the alternative space?
00:01:21
Speaker
Sure, I've been in the investment industry for 22 or 23 years at this point and it's all been in alternatives. First, call it 10 years or so in a variety of roles, asset management, broker-dealer. I spent some time at an investment consultant doing manager research across hedge funds. Then I spent about 10 years in the institutional space where I was an allocator at a couple of different state pensions.
00:01:46
Speaker
built portfolios across hedge funds, private credit, private real assets, private equity, nearly $7 billion of committed capital and probably 3,500 GPs that I met with.
00:01:58
Speaker
And then I have a few years as a investor in alternatives for high net worth clients at first the boutique kind of alts platform and then at a wealth management firm. Currently I'm an independent advisor working with RIAs, small institutions, family offices, and in some cases asset managers to help them in decision making across alternatives. Oh, I just wondered, you know, what do you find most appealing about the alternative space?
The Appeal and Evolution of Alternative Investments
00:02:27
Speaker
Yeah, to me, I mean, alternatives is where innovation and creative disruption sort of occurs in the asset management industry. I think, I mean, there's plenty of very smart, very driven, highly competitive people in investing broadly, but alternative seems to be where you have the smartest kind of most driven people searching for kind of new sources of investment returns, right? A new edge that they can have and execute against. And so,
00:02:55
Speaker
From an investor's perspective, not only is it the most interesting, but I think it's where the most compelling investment opportunities tend to exist. And how would you say, you know, perhaps the, you know, the reputation of alternatives have evolved through the years?
00:03:11
Speaker
So it's definitely, yes, definitely changed. I think today, if you consider alternatives that the name probably doesn't necessarily fit their very mainstream. I have a friend who likes to say that today alternatives are sort of traditional plus.
00:03:26
Speaker
Over the course of my career, they've gone from something that is really reserved for sophisticated investors and big institutions. 20 years ago, maybe endowments and foundations and public pensions and family offices were kind of the sole participants in that market. Today, they're not truly alternative. Like I said, they're just another tool in most investors' toolbox and even individual investors can participate.
00:03:57
Speaker
What would you say your main beliefs are with incorporating alternative investments into a portfolio? I think they provide the same things that traditional investments provide.
00:04:11
Speaker
And I think this speaks to like why they've grown in acceptance and incorporation in investor portfolios. Really think about what you get from any investment. There's only a handful of things. We can make it super complicated, but if you distill it down to these fundamental characteristics, you get, you get capital appreciation, you get income.
00:04:30
Speaker
you get diversification benefits slash risk reduction, and maybe you get, some people would argue, you get capital preservation. I think that's more savings, less investing, so I'd leave that one aside, and I think those first three things are the core building blocks of any portfolio. Capital appreciation, income, diversification slash risk reduction.
Shifts in Traditional Markets and Growing Interest in Alternatives
00:04:52
Speaker
What you get from incorporating alternatives in my opinion is you get more of those things meaning. If I want capital appreciation I can allocate to traditional stocks or private equity or risk seeking hedge funds if I want income I can allocate to investment grade or high yield or I can allocate.
00:05:12
Speaker
To private credit i think alts in some sense are more capital efficient than what you get from traditional asset classes for each dollar. Allocated right you get more of those things and sometimes you get more of those things with less risk even which is kind of the holy grail of investing right all heavy portfolios.
00:05:32
Speaker
have been shown they have less equity beta, less equity sensitivity, they have lower volatility and shallower drawdowns which are kind of the benchmarks for how you measure risk. So I think that's the allure of alternatives and that's why they've increased in dominance.
00:05:52
Speaker
Yeah, could you just elaborate a little more on that, the current state of traditional markets and how that has impacted the interest overall for alternative investments in this space? Sure.
00:06:06
Speaker
Yeah. If you think of, um, stock and bond markets really just over the course of my career, I mean, they've done well, right? No question. I mean, stocks over the last 10 or 20 years have given you a 10% sort of rate of return, but they've done that with considerable volatility. Again, during my career alone, I've seen the stock market double and then half and then double and then half again, and then triple from there. And then two 20% declines within two years.
00:06:35
Speaker
Not to mention that, like where we're at today, the market doesn't really look like what it did 40 or 50 or 60 years ago. And so you've got this long track record of great performance of public equities in the United States, but today,
00:06:48
Speaker
Right, dividends are just lower than they were. They're a big percentage of the return driver in equities. You've got EPS growth, less of which today is coming from sort of top line growth and more is coming from share reduction and cost cutting, things like that. You've got fewer stocks in the stock market today. There's about 4,000 publicly listed stocks between the various exchanges in the United States, whereas 20 years ago there was 8,000 or 9,000.
00:07:15
Speaker
And that means that you have more concentrated stocks. I mean five or six stocks this year have driven something like 25 or 50% of the total return of the S&P. And you are starting at a higher level of valuations. Multiples today are substantially higher than they were 20 years ago or even 40 years ago. And so all of these
00:07:34
Speaker
You know, reasons give investors concerns that the returns to public stocks going forward won't necessarily look like they did historically. If you look at bonds, you see the same thing, you know, from 1980 till, well, a year ago, rates went effectively from 15% to zero.
00:07:53
Speaker
That's an incredible tailwind for fixed income. But at that point, when rates are at zero, when IG is yielding 1%, that's effectively not risk-free rate of return, it's return-free risk.
00:08:09
Speaker
Um of course today money markets are yielding whatever four and a half percent so that math has changed but still you don't get going forward from a traditional fixed income portfolio what you you may have gotten over the last 40 years and so all of these things
00:08:25
Speaker
have led to more interesting alternatives to sort of replace those drivers of capital appreciation and income. I think 2022 was actually like the perfect real world proof point for Alt's heavy portfolios for a long time. 64 to continue to do good despite sort of all the naysayers and people use that as an argument why you don't need to complicate your portfolio.
00:08:47
Speaker
Then 2022 happens and there's a big difference between being down 15% or 20% and being down 2% or 5%. There's big behavioral implications for those as well as far as sticking with your asset allocation and not making the wrong decision at the wrong point. I think last year only increased the interest in and the demand for alternatives going forward.
Technological Impact on Alternative Investments
00:09:14
Speaker
All right. So, you know, as the alternative landscape, you know, continues to evolve, what are some of the emerging trends that you're seeing in the coming years and how would you advise, you know, investors to stay ahead of the curve? Yeah, I think the evolution of alternatives is a huge component of what investors need to be aware of. I mean, certainly it's a complicated
00:09:42
Speaker
segment of the market, and we've seen a lot of changes over the last decade from the flood of capital, the last two decades from institutions. I think we should expect similar impact from individual assets coming into the space.
00:09:58
Speaker
like truly appreciate the scale of that impact. So for perspective, from 2000 to 2020, you know, institutions that were historically five to 10% alts went to 30, 40% alts. And the industry which started out at, call it $2 trillion has grown to 13, 14, 15 trillion in assets under management. And that's massively changed the industry along the way.
00:10:24
Speaker
Now you've seen the erosion of alpha in traditional hedge fund strategies, the growth of very large alternative firms. You've seen PE mega deals and concentration of assets with winners. And now today if you look at
00:10:42
Speaker
the assets in the individual channels, they're on par with institutions. So call it 65 trillion of assets managed in the United States, half institutions, half retail, but retail is growing twice as fast because institutional investors have very high spending rates.
00:11:03
Speaker
When you look at trillions and trillions of dollars sitting there, average allocation is maybe two to three percent in alternatives, and you can see this evolution that will likely follow the path laid out by institutions. I think it's reasonable to expect twenty trillion dollars of assets to come into alts from the retail channel over the next twenty years.
00:11:27
Speaker
quite honestly, I have no idea what the implication of that is or what that means for alts, but I think it's probably likely to look a lot different than it does today. So just like some big picture thoughts, I think over the last five years, what have we seen? Well, we've seen the growth of the alts exchanges, the platforms where vehicles are then made accessible to individual
00:11:53
Speaker
investors. They're basically new exchanges, tech enabled exchanges. We've seen interval funds explode from effectively nothing five years ago to maybe a hundred funds today and tens of billions of dollars. So I think that big trend is continued deployment from individuals into the space. And I think investors need, you know, investment advisors need to be aware of what this means. They have to be willing to learn and adapt
00:12:23
Speaker
and evolve and I mean at some point you have to be willing to kind of kill what's not working and do something different because I can guarantee you in 20 years it's going to look a lot different than it does today.
00:12:34
Speaker
I'll touch base a little bit more on some of that, you know, like alpha in just a moment, but I do want to dig a little deeper, you know, as far as for individuals who are looking, you know, to explore in the alternative space, you know, what kind of resources or educational opportunities do you have that you can recommend, you know, for people to help enhance their decision making in this complex, you know, area?
00:13:00
Speaker
I think there's a lot of resources available and a lot more today than there was 10 years ago. As I mentioned, those exchanges, things like iCapital and Case, they're a platform that allows individual investors and investment advisors to access hedge funds and private equity for their clients and makes the entire process more seamless. But they've come to realize that a big component of
00:13:24
Speaker
facilitating that exchange is helping out on the educational side. So they have a lot of content available on private equity and hedge funds and increasingly technical detail. I'd say you also see some of the big investment managers that are in alternatives investing more and more into education. For example,
00:13:45
Speaker
Apollo has launched Apollo Academy with Keith Black from the KIA and from UMass to basically provide video content and individual modules on alternatives for people. So you can access things like that.
00:14:01
Speaker
Of course, there's the KIAA Association, the Chartered Alternative Investment Analysts Association, which has great content. They're actually launching a new credential called UNIFI, which is focused on RIAs and wealth managers and helping them
00:14:19
Speaker
get credential, but of course learn more about how to build alternative investments for their clients. I'm biased because I'm producing content for both the KIAA curriculum and Unify, but I think it's very good. And at the end of the day, there's just a ton of research that's produced by practitioners and academics, Financial Analyst Journal, the Journal of Alternative Investment. There's no shortage of research in white papers that you can go access for free if you're so inclined.
00:14:49
Speaker
And I mean, you know, this is a totally new space for me too, as I've been very, you know, just authentic and open with my listeners, you know, and just inviting everyone to learn with me. I actually have been taking the course by Unify by Kaya on alternative investments. And our very first guest actually was Erin Philbeck. So it's been quite a journey learning a lot right now.
Emerging Trends in Alternatives
00:15:13
Speaker
In this space so yeah, it's really really exciting exciting time So well, that's awesome to hear that you're putting that to use and Eric I mean Aaron he did he did loop me in to help design some of the content So I'm working on some more and you'll have to let me know how they go
00:15:33
Speaker
I will, I will. They're lucky to have you, and so are we. So looking ahead, what do you see for the future for alternative investments? There's emerging trends and innovations, but what ones do you feel are the most promising right now in the space?
00:15:49
Speaker
Yeah. Like I said, I think it's really, it's difficult to predict the future of alternatives. There's, there's things that have happened that I would have never suspected happen. And so I think it almost evolves of its own volition. Like you have to, again, realize it's brilliant investors and traders searching for the next big thing. Um, so you've got to be willing to kind of kill your past idols and have adaptive models. We can talk about that a little bit more.
00:16:13
Speaker
I think some of the areas specifically that are most interesting, there's a couple of different things. I think the increasing adoption of a GP stakes model where a fund or an investor owns a portion of another fund, of a private equity fund or a hedge fund and owns shares in the revenue from those funds is very interesting. You're seeing more and more firms come out to compete in that space.
00:16:41
Speaker
I think other asset managers will buy boutiques and sort of build boutiques of boutiques. I would not expect that trend to slow down. I think there's going to be more and more innovation in secondary markets, so where investors have
00:16:59
Speaker
an interest in a fund and they want to look to sell that fund to other investors. That's effectively what some of the interval funds are doing. You've got venture capital right now, which is pretty interesting. And I think that will become much more liquid. As people create vehicles to trade these shares in the funds on the secondary market, they'll create more and more liquidity in the venture capital space.
00:17:27
Speaker
The other big trend, we sort of talked about this, is just the bifurcation between the big and small. I mean, that's happened for 20 years. The factors that are leading to that, they're only getting bigger. So I would suspect you see massive asset management firms that grow within the alt space and look more and more like traditional asset managers. And I think smaller firms will be able to sort of innovate and
00:17:52
Speaker
stay nimble and retain their performance edge. There's a couple of statistics I like to point to from 2022, again, that I think reinforce this. Last year there was $500 billion worth of private capital raised in the US, and there was something like 2,000 funds in market. 45% of those funds were only seeking to raise a fund of $200 million or less. So pretty small funds, almost half the market.
00:18:18
Speaker
However, the capital that was raised of that 500 billion, just 1.5% of the total capital went to those small funds. So it's harder and harder for small funds to raise capital, which somewhat perversely creates more opportunity there. I think you kind of, also you need to go where capital doesn't go in some ways. You've got to scale the business, but you've got to continually find these pockets of less capital. And so I think seeding managers or small managers
00:18:49
Speaker
I think advisors need to be aware of that space.
Critique of Traditional Investment Approaches
00:18:53
Speaker
So I want to ask some questions actually specific to your book, Better Than Alpha, the three steps to capturing excess returns in a changing world, which is definitely on my list of books to read. So can you explain the concept of alpha and why you believe this is actually a flawed approach to investing?
00:19:16
Speaker
Sure, the classic definition of alpha is just excess returns above a benchmark index return. And the benchmark is supposed to be risk matched to the portfolio. So you shouldn't have stock alpha over a bond index.
00:19:33
Speaker
That's the problem, though, because in my experience, I think most of what has looked like alpha historically has actually just been a benchmark mismatch. So let's kind of walk through what does that mean? Well, historically, there have been managers who've consistently beaten their benchmark in bonds, in stocks, and in hedge funds. But what you found at
00:19:55
Speaker
at the end of the day is that they had tilts in the portfolio. So value, that's the most well-known tilt, right? You buy stocks that are cheap relative to their book and you just own them and you outperform the market. But it might be a quality tilt, right? It might be a dividend tilt. It might be sector concentration. All these things, when you actually do the performance analytics, what you find is that probably
00:20:19
Speaker
You know, the number of managers that actually generated true alpha is like statistically indistinguishable from zero. I mean, there's maybe a handful. Everybody else has had this tilt in their portfolio. And when you actually put the correct benchmark in place, it's not there. The easiest example is investment grade bonds, right? So that's a benchmark. You can just buy an ETF and get that portfolio.
00:20:43
Speaker
I cannot perform that if I just do 90% of my portfolio in the IG benchmark and then 10% in a high yield. And from a vol perspective, it's a little bit more risky, but you will historically generate big alpha. Well, it's not actually alpha. And so to me, that's a failed paradigm.
00:21:06
Speaker
And even within active management, 90 plus percent of mutual funds that are active, they fail to beat their benchmark over 10 year periods.
00:21:14
Speaker
When you couple that with the fact that individual investors have been shown to buy mutual funds high and sell mutual funds low, they do even worse than that 90%. And so trying to chase a benchmark to beat has proven to be a recipe for failure. And I just don't think that that's what people should be focused on. I think there's a little bit
00:21:41
Speaker
better and more conceptually easy to understand approach. Benchmarks play a role, but you shouldn't build a portfolio to quote, unquote, beat a benchmark.
00:21:50
Speaker
Yeah, good point. Good point. So while in your book, you do emphasize the importance of behavior, process and organization for making, you know, better investment decisions.
Structured Decision-Making in Investing
00:22:04
Speaker
So could you provide some practical examples and, you know, strategies for implementing those principles?
00:22:11
Speaker
Sure. So I've kind of distilled down investment decision making to a couple of different layers. And that's sort of what those three steps are. They're really about where does your organization, your firm, et cetera, make investment decisions. And so I'll, you know, behavior process organization, I'll start with those first two, because I think they're kind of at the individual level. Behavior and process are very highly related to
00:22:40
Speaker
Dan Kahneman's two types of thinking. So thinking fast, thinking slow, probably the most influential book I've ever read. You should read that instead of my book, just full disclosure. And Kahneman talks about type one and type two thinking. So type one is very fast, intuitive. It's kind of gut decision making. Type two is very intentional. It's high energy usage. It's kind of what we do when we take a test.
00:23:09
Speaker
I think the biggest problem that I've experienced in the investment industry, whether it's an institution, whether it's a firm, is that most people think they're using type two and they're actually using type one. And that means you wind up just making gut decisions that you think are really rational. Or when you try to do objective research, you're actually just justifying what that gut decision already was.
00:23:35
Speaker
Yeah, I wrote those chapters to kind of create process around improving our decision making. And I'll start with the behavioral one. I think smart thinking to me is being very intentional with that limited system to resource. So let's use the example of like a strategic asset allocation.
00:23:54
Speaker
Research shows 90% of the returns of your portfolio are gonna come from what asset classes you pick and how much you put in those asset classes. That's it. Picking the managers, picking the stocks matters, but 90% comes from that one decision. That is a very strategic, hence the strategic asset allocation decision, but it's also one that you should allocate a lot of time to. So to me, you'd be limited with your use of discretionary judgment. Make few
00:24:21
Speaker
highly impactful decisions. We have a tendency to try to be super busy, do all these things at once. We think we're all multitaskers. We're not. We task switch. When you do that, you do each of the individual decisions slower and worse than if you allocated time to them independently.
00:24:42
Speaker
Do that. Try to block out white space on your calendar. If you know we're going to get into alternatives, be very thoughtful about that. Spend a lot of time doing research on it. Focus on three to five super important things rather than the 97th input into the model. So to me, that's the behavioral side of it. Really be intentional, be mindful, kind of overcome your tendency to want to be super active and make a ton of decisions. The flip side of that
00:25:11
Speaker
is on the process alpha side, we still have lots of decisions to make. Researchers say you have 40,000 decision points every day. And that sounds crazy, but when you think about it, it actually is pretty legit. By the time you've got to work, you've probably made 1,000 decisions. You just haven't thought about it. Do I turn? Do I go straight? There's a yellow light. Do I hit the brakes? Do I gun it? Do I wear this belt or those socks?
00:25:38
Speaker
Those are all the subconscious ones that we haven't really spent a lot of time thinking about. Now, in most arenas of life,
00:25:45
Speaker
it's fine. But in investing, which has become increasingly complex, more and more data, our system tends to make easy decisions rather than good ones there. And so my advice is that people should use intentional system to thinking to set up process to eliminate those decision points. What I mean is systematize and automate as much as you possibly can. So a couple of examples would be we talked about
00:26:14
Speaker
Strategic asset allocation that needs to be very intentional think about clients liquidity needs, right? Think about their sophistication think about their time horizons all those constraints Tactical asset allocation is kind of real time, right? It's where you adjust you rebalance You should have rules about that and those rules should be very data dependent. It's not
00:26:37
Speaker
It's not trite to build a successful tactical asset allocation model, but you can do it and it shouldn't really have a ton of discretion, right? Capital markets, prices, risk premium in the market, things like that should drive that. Or let's talk about due diligence. Checklist kind of in place where you can validate individual things and try to put qualitative numbers around what is otherwise just quantitative inputs.
00:27:07
Speaker
So that's the process. I think 90 plus percent of what you do in investing should be turned into a process. Lastly, and it's maybe the most important, is what I call organizational alpha. It's the governance of how you make decisions. And really, it's broadly speaking, it's the rules and policies and procedures of how you oversee investment decision making and execution, but simply
00:27:36
Speaker
Governance is deciding who decides. And again, it may sound trite, but you have to have the right people in the right positions to make the right decisions. It's really important. There's a ton of research that shows if you don't, you underperform. But I think a simple way to do it is just a decision matrix.
00:27:57
Speaker
And so I've seen this in institutions where you sit down and you say, we have a board, we have an investment committee, we have a CIO, we have portfolio managers, we have analysts. And then what are the decisions we have to make?
00:28:09
Speaker
Setting policy, strategic allocation, manager selection, rebalancing, risk management. Right. Intentional governance means picking the people who are the most qualified to make those decisions and then empowering them. Um, might be a difficult conversation, but it's one that you should have. And right. It requires the CEO to go, I'm not the expert at this or a managing partner to say,
00:28:36
Speaker
I want the analyst's input because he's done this for five years and I haven't. But you've really got to do that, particularly if you're going to move into alternatives for the first time in order to make sure that you're making that best decision. You can't have right behavior and process alpha without having that organizational alpha first. So important to have the right people in the decision making process.
00:29:02
Speaker
So many investors, they still believe in the concept of beating the market and actively searching for alpha, you know, as we were saying, just to revisit that again.
Importance of Personal Financial Goals in Investing
00:29:14
Speaker
So your book, do you think it can convince them to shift their mindset, you know, to these values that you're, that you're saying? I don't know if, yeah, I don't know if it can convince them, but I would make the argument that they should.
00:29:28
Speaker
Benchmarks are a requirement. Trust what you're saying. Just do it. Trust me. Benchmarks are a requirement of the process. And there's a role for them. But what I would argue is that everyone needs to be a hurdle rate investor, not benchmark linked. And what does that mean? Well, a hurdle rate is just a required rate of return. And it can be very different for different investors. So an endowment might need to spend 5% a year.
00:29:56
Speaker
Okay, add inflation onto that. Maybe they need to earn seven and a half. That's their hurdle rate. But for someone in retirement, they have income needs. You can set up a portfolio to generate certain income and you need to know what it needs to earn in order to do that. Or if you're trying to save for retirement or save for a house, it's the rate of return that you need to achieve over some time period. And frankly, risk isn't all.
00:30:24
Speaker
Volatility is noise. It's a choppy path that goes from point A to point B. What clients care about isn't a Sharpe ratio, it's success. And success means meeting that hurdle rate or exceeding that hurdle rate. Failure is not hitting that. So I think the argument I would make is you should be focusing on things that have a higher probability of generating that rate of return as opposed to beating a benchmark.
00:30:49
Speaker
because we don't eat sharp ratio. We don't even eat alpha. We spend from total net return. Clients are going to be paying their bills from the total net return. So that's what I would argue. Lean into the things
00:31:04
Speaker
that increase your odds of success. And if you do the research on behavioral alpha, process alpha, organizational alpha, what you find is if you get those things right, they add return pretty convincingly and pretty consistently. And those are inside of your control, importantly. What the market does is what the market does. I've come to learn
00:31:25
Speaker
it's like the ocean or it's like the weather it's just gonna do what it's gonna do when you're along for the ride but if you control your behavior you put process in place you control your decision making that's one hundred percent within your control and you can add alpha or you can add a higher probability of making your required rate of return.
Continuous Learning in Investment Strategies
00:31:45
Speaker
I think that's excellent advice.
00:31:48
Speaker
As we discussed, the whole industry really has evolved, especially in the last few years, and it's just constantly, rapidly evolving. In your book, does it address the changing nature of markets and provide insights into strategies that can be effective today, even if it didn't work in the past?
00:32:16
Speaker
Yeah, I mean that was really the whole conception of the book was about the evolution of Alpha and how it changes. So part of writing process was putting a systematized learning process in place. If you think about how historically investors have generated Alpha, one constant is that that constantly changes. So what works today isn't necessarily what worked in the past.
00:32:43
Speaker
you know, value has not outperformed growth for a long time. Small caps no longer outperform large caps. I mean, convertible arbitrage basically doesn't work. Even Warren Buffett, he doesn't, you know, implement a strict Graham Dodd approach to value investing. And he says it himself, like he's got, you know, IT in the portfolio. He values intangible assets when trying to understand a business's competitive moat.
00:33:08
Speaker
And so you have to evolve over time. I think, you know, that's actually the evolution of alpha to beta. What looked like alpha historically is likely going to be accessible as cheap beta at some point. And so if I wanted to do value,
00:33:25
Speaker
What I don't want to do today is go hire some active value manager at a 1% management fee. I'll go buy an ETF that has a value tilt for 14 basis points. It's the same thing in alternatives. You can see merger arbitrage. In the late 80s and early 90s, basically everybody spinning out from Goldman Sachs risk arb desk generated alpha because not everybody else did merger arb. Well, today,
00:33:50
Speaker
That's basically another beta and you can go buy dedicated merger arb exposure in different packages for very cheap. It's not two and 20 anymore.
00:34:00
Speaker
That's the natural evolution of markets. People learn how to do things. They spin out and they do it themselves, and then more people come to market with cheaper products that do the same thing. So you have to understand that's what alpha does, and your process to help you access that has to have feedback loops. So we talk about process and process being inside of your control, but at the end of the day,
00:34:25
Speaker
The market is the boss and there's that output that you can measure and if it's not working right how do you learn from that why would say. Systematize what you need to do to make that decision but then systematize what has to happen for that decision to be successful how you measure the outcome.
00:34:43
Speaker
And then systematize what do you do if it's not working? So where do you go to investigate improving the portfolio? Was it manager selection? Was it asset allocation? And correct it if it isn't. If there's one takeaway from the entire book, it's that learning process is what's required to ensure you stay on the positive curve of alpha evolution. That's right. Never stop learning. Never stop learning.
00:35:09
Speaker
Yes.
Conclusion and Call to Action
00:35:10
Speaker
Do you have that? That was so great. Thank you so much. Do you have any, do you have any other like final thoughts or anything else that you want to add in? No, I mean, I think you hit the nail on the head, right? It's, it's all about learning. Again, it sounds quite, but it, Warren Buffett reads eight hours a day. And, and I think you can take a lesson from that. Just constantly learning. Don't let anything become, um, proscriptive, right? Just keep learning and learning and learning.
00:35:38
Speaker
We never stop learning and growing until we're dead. I can't thank you enough. I really enjoyed this very much. Everyone listening definitely go out and buy his book. I'm really looking forward to continuing to grow and learn together.
00:35:58
Speaker
this space so Chris thank you so much for taking the time today to chat with us about alternatives and it's been very informative so everyone listening thank you so much for tuning in and be sure to just you know check out and check up on updates follow us on Instagram Twitter bannering capital LinkedIn follow us on all of the social networks and forward to next time
00:36:28
Speaker
Bye.
00:36:34
Speaker
The opinions expressed in this program offer general informational purposes only and are not intended to provide specific advice or recommendations for any individual or any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Any past performance discussed during this program is no guarantee of future results.
00:36:59
Speaker
Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always, please remember, investing involves risk and possible loss of capital. Please seek advice from the licensed professional.