Total eclipse of the sun
A little over two weeks ago the coast of Oregon paid host to a total eclipse of the sun. It began at 9:06am local time, when the sun’s glaring disc started to develop a small but growing dimple. By 10.19am the sun’s indomitable force was reduced to a bizarre glow, a doughnut of light in the sky punched through the middle with cosmic blackness, as a curious dusk temporarily descended on the millions that had gathered to witness the event. Total eclipses of the moon are rare, and worth celebrating, and those that have witnessed them profess to never forgetting them. We now understand the science behind them, but ancient cultures saw dragons of the sky devouring their sun, and tried to frighten them away with whatever weapons were to hand. Or they represented great omens of the future, tools for fortune tellers and soothsayers alike to work their magic.
Although we have understood the astronomy behind eclipses for centuries, less than 100 years ago in 1919 an eclipse shook the world of physics. Albert Einstein had recently penned his theory of relativity, audaciously describing how gravity could bend light, and alter the perceived position of stars close to bright light. Telescopes were not sufficiently sophisticated to prove his theory, but 1919’s eclipse offered a unique opportunity to amass the requisite evidence for an indisputable proof, as stars close to the sun momentarily became visible to telescopes.
As an amateur astrologist, I paid close attention to the eclipse, albeit remotely from a dusty Greek island where I was holidaying with my family. However, it got me thinking about today’s world where evidence abounds, compared to the mythologizing of the ancients to explain phenomena they could neither understand nor explain. There are of course parallels to the study (and journey) of modern finance, and the quest for elusive alpha – the magic gold dust sprinkled onto market returns (beta) by money managers to generate superior returns. Back in the dark ages of modern finance (first half of the 20th century), wealthy individuals invested with stock brokers who typically generated alpha through tapping into the old-boy-network. When this was closed down through legislation against insider trading, managers tapped into alpha through overweighting small or value or profitability, that is until the science caught up with the mythology of alpha, and the bulk of the returns could again be explained by beta.
In Adam Berger’s excellent paper entitled: “Is Alpha just Beta waiting to be discovered?”, he elegantly introduces his hypothesis as follows, articulating the point more clearly than my clumsy attempts above:
Alpha is shrinking, and it’s good news for investors. This idea may seem paradoxical. But alpha is really just the portion of a portfolio’s returns that cannot be explained by exposure to common risk factors (betas). With the emergence of new betas, the unexplained portion (alpha) shrinks – alpha gets reclassified as beta. The rise of a group of risk factors we call hedge fund betas makes this transformation especially relevant today. Hedge fund betas are the common risk exposures shared by hedge fund managers pursuing similar strategies. We believe these risk factors can capture not just the fundamental insights of hedge funds, but also a meaningful portion of their returns. Hedge fund betas are available for investment and can also be used to enhance portfolio construction and risk management. Ultimately, we believe the rise of hedge fund betas will lead not only to the reclassification of alpha, but also to better-diversified portfolios with greater transparency, improved risk control, and – perhaps most importantly – higher net returns.
As regular readers of this blog will know, at MASECO we look to expose our portfolios to a diversified range of betas in a low cost environment, more commonly known in today’s parlance as Smart Beta.
Risk Warnings and Important Information
The value of investments can fall as well as rise. You may not get back what you invest.
The above article does not take into account the specific goals or requirements of individual users. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.
MASECO LLP trading as MASECO Private Wealth is authorised and regulated by the Financial Conduct Authority, the Financial Conduct Authority does not regulate tax advice. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this document.