Tuesday, January 08, 2008
The Economist recently published a piece on Alpha, and upon reflection, I find it both fascinating and somewhat ironic that as leverage systemically drains from the parallel dimension banking structures as a result of sub-prime bullet-wounds, institutional equity investors, typically late to the party in the best of times, not to mention, rarely-right, are in the process of piling into 130/30 funds on the rationale that leverage is (contrary to current sentiment in the credit markets) NOT poison, but downright useful. So useful, in fact, that proponents apparently believe that it [the leveraged long vs. short portion] should be institutionalized, and set at fixed ratio atop an outright long portfolio, and we should call this "a product" in its own right.
*Blink*-*Blink* (eyes flutter open and shut quizically !!)
So, who's right? Should equity investors be maintaining 100% long exposure and be systematically employing leverage in an ATTEMPT to siphon some alpha from long vs. short specutrage, where the spec vs. benchmark is limited to a single asset class (e.g. cheap vs. dear equity spread)?? Or, IF leverage is, in fact NOT poison, perhaps the investor shouldn't be so limiting in his application of leverage to a corner of a single asset class.
There are some plausible, if not valid arguments for why coordination between long-only beta and relative-value alpha might not be a bad thing, such as avoiding position duplication (long in one portfolio and short in another), transactions costs minimisation, possible fee optimisation, reduction of stock-borrowing and financing costs, in addition to some I might not have thought of. But do these outweigh the institutionalization of leverage in the hands of someone, or more importantly some pseudo-asset-class (call it: equity value spread) who or which might not be providing the best risk-adjusted alpha per unit of leverage in comparison to the total opportunity set?
Counter-arguments please, for I know I sound curmudgeonly here, but looking at the big picture, it seems that 130/30 is the financial equivalent of using an OTC cough syrup to treat a serious bacterial infection where a scrip of higher-octane antibiotics are perhaps the more-correct prescription. Or perhaps its akin to Lite Beer or Oleo-Margarine, both of which are wholly inferior to the real ideal upon which they are modeled, and provide such little benefit relative to their pathetic quality, it makes one suspicious of ultimate motives behind their existence. To me, leverage is binary: either it makes sense or it doesn't. IF leverage makes sense, then, why constrain oneself to employing it parsimoniously and sub-optimally? IF on the other hand it doesn't...