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robert webb

Given the improvement in technology and the speed of information dissemination in our present era, investors may wonder if there is any alpha left out there in the financial markets. It is a valid and crucial question that any active investor has to consider.

In July 2014, Professor Robert Webb of the McIntire School of Commerce at the University of Virginia was in Singapore at the Singapore Management University (SMU) to talk to members of CFA Society about what academia has found from its studies about alpha in the market place – mis-pricings are more likely to arise in turbulent than tranquil markets, when there are limits to arbitrage.

Published in the CFA Singapore Quarterly Newsletter (Issue #15) in October 2014, Professor Webb revealed a variety of avenues in which alpha could possibly still be found and extracted. However, they tend to be characterized by volatility and turbulence. BillionaireInvestor will share just three interesting points in this commentary:

(I) Forced Alpha – The Amaranth Case

The infamous case of the hedge fund Amaranth Advisors LLC (a multi-strategy hedge fund) that imploded was brought up by Professor Webb as a case of ‘forced alpha’.
“Amaranth was long and wrong on the March 2007 – April 2007 natural gas spread. The spread which was at a premium of USD 2.14 per MMBtu, collapsed in two weeks to 75 cents by 18 September when Amaranth threw in the towel. Most of the USD 1.39 decline in the spread (and hence trading loss incurred by Amaranth) came after Amaranth was identified as a trader in trouble. Amaranth initially reported it had lost USD 1-2 billion. The ultimate loss a few days later was USD 6 billion. Some of the largest changes in speculative prices often have little to do with the arrival of new fundamental information or noise trading.

(II) Politics & Alpha – The 2012/2013 Japanese Resurgence

Another point that Dr Webb brought up was the idea that alpha could be derived from anticipation of political events or developments. While seemingly speculative in nature, investors who understand significant political events and their likely influence on the business and finance environment could actually benefit if positioned properly. “Sometimes the biggest source of alpha is in anticipating a political action. For instance, arguably the largest source of profit for many global macro hedge funds in 2012/2013 was betting on a lower yen and higher Japanese equity prices following the election of Shinzo Abe as prime minister. The incoming Japanese government telegraphed in advance its intentions to reduce the value of the yen. This was a political event with significant consequences for the yen and Japanese stock prices.”

(III) Law & Alpha – Argentina

Dr Webb also suggested that understanding the law and the regulatory environment is crucial when it comes to investing. In our present age where global investing has gone mainstream due to the need of diversification, this is a vital point to consider when constructing a portfolio. “Sometimes alpha is earned from understanding law or how regulations might be administered better than others. The recent decision by the US Supreme Court not to hear the appeal by Argentina to a lower court ruling against it by holdout bond owners is a good example of how alpha may arise from a better understanding of law and politics. The Argentine bonds that some vulture funds bought were under-priced due to a misunderstanding of law and/or politics. Understanding both law and politics was important in this case.”

Professor Webb also shared about how renowned investor Warren Buffett earns alpha over the years in managing Berkshire Hathaway, and concluded with 8 different points by which investors may capture alpha from the markets. For the diligent and the most persevering, alpha may not be just a dream!

The full issue published by CFA Society Singapore may be found here. For more information on Professor Robert Webb and his work, readers may visit the University of Virginia’s website here.

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