Alpha on Life Support

Terry Flanagan

Cloud computing and low latency are de rigueur for asset managers as traditional sources of alpha erode.

“There simply isn’t any more alpha, and it’s not just because of a slow economy or a reduction in equity inflows,” said Scott Appleby of Appleby Capital.

The internet, in Appleby’s view, is one of the primary reasons for the death of alpha.

“By providing a low-cost communications tool for companies to disseminate information to investors simultaneously, the internet has greatly diminished the traditional role of intermediary for investment banks, if not moved it to obsolescence,” he said.

Appleby Capital, founded by Appleby, a former financial technology analyst, focuses on financial technology mergers and acqusitions and capital raising.

Scott Appleby, Appleby Capital

Scott Appleby, Appleby Capital

Its coverage includes brokers, exchanges, liquidity providers, market data, software and services, and alternative asset managers.

“We look for good companies that are technology-focused and operate in the capital markets space,” said Appleby.
Another traditional source of alpha—initial public offerings—is also going the way of the dodo bird.

“The IPO calendar, long a material alpha generator, has fallen to just 14% of the number between 1995-2000,” Appleby said. “Even when there are deals, private equity firms are now the ‘customer,’ and not the institutions.”

As a result, the IPO discount of 15% has been largely eliminated and is being absorbed by the selling shareholders.
Twitter recently announced that it was going public via a tweet. “Twitter does not need Wall Street,” said Appleby. “They will go public themselves if they can find a legal way of doing it.”

Yet another enemy of alpha is electronic trading. “Electronic trading, when combined with the increased fragmentation of execution destinations and the lack of natural order flow, because there is no research call, has put pricing pressure in the hands of the buy side,” Appleby said.

In order to remain relevant, Wall Street will have to invent new ways of replacing lost alpha, such as managed services.

“As investment banks and institutional asset managers cut their internal technology spend in favor of out sprucing, managed services will take hold as the optimal solution,” Appleby said.

For example, Liquid Holdings Group provides hedge funds with a cloud-based trade execution and risk management platform. Hedge funds and active traders are able to replace multiple legacy software systems and realize cost savings due to Liquid’s SaaS delivery model and outsourced managed services.

“Leveraging the cloud to provide hedge fund managers with institutional quality trading, risk management, reporting, shadow accounting and managed services in a single platform is a game changer,” said Liquid CEO Brian Storms.
Liquid has recently enhanced the platform with expansion of destination and broker-neutral order routing, a post-trade allocation engine, and pre-trade compliance.

“These enhancements demonstrate our commitment to continually expand our capabilities to accommodate the needs of our growing list of hedge fund and active trading market clients,” Storms said.

Active management styles represent another casualty of the loss of alpha, as there are no longer opportunities to extract alpha via long-short strategies.

“Prior to 2002, many large mutual fund complexes and hedge funds exhibited market-beating results, as investment banks conveyed alpha through proprietary research and IPOs,” said Appleby. “Now, after a decade of underperformance, mutual and hedge fund managers will continue to experience significant asset erosion.”

Wirehouses without alpha and with high-fee models are losing assets to passive investment models, such as ETFs, as well as custodians such as TD Ameritrade, Schwab and Fidelity, he said.

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