Investors tend to flock to straight forward alternative strategies like equity long/short because they believe they are easier to understand. We believe alpha is hard to come by and easily imitated. Over-capitalized investment strategies no longer offer attractive returns. To source alpha, one must be willing to engage with complicated and under-followed areas of the financial markets.
Focus on the Tail
Investors spend the bulk of their time analyzing historical averages and contemporaneous correlations. We believe this approach leads to faulty decision making. Some strategies, like event driven, exhibit a low average correlation to the equity market, but then lose money in times of market stress. Investments that are uncorrelated when equity markets are normal or rising but correlated in rapid market declines are unlikely to add value to an investor's portfolio. We work to identify investment strategies that can benefit from tail events. While capital markets are largely efficient, alpha can be found in strategies that focus their efforts on understanding the full distribution of potential outcomes.
As we saw in the financial crisis, whether it was rating agencies compensated by borrowers, investment banks seeking short-term profits, borrowers being offered near-free money, lenders assuming they could securitize away risk or insurance companies maximizing return for the rating, misaligned incentives drive faulty investor decision-making. We are often early investors in the strategies we pursue, and we work to ensure that our incentives as well as those of the strategies in which we invest are aligned with our investors' best interests.
Investors consistently overestimate their own skill in identifying attractive investments and underestimate the percentage of potential poor investments. As an example, academic research has shown that as much as ninety percent of equity long/short managers do not add value net-of-fees, but investors seem to think that they can find the one in ten that is. This is hubris. Even if an investor is capable of differentiating a good manager from a bad one ninety percent of the time, given the above percentage of poor managers in the market, the investor still only has a 50% chance of picking one that is worth the fees. We believe that by looking for attractive investments in pockets of the financial markets where there is less competition and by sizing our investments with a recognition of our own and market uncertainty, we can deliver stable, attractive, uncorrelated returns.