The Benefits Of Manager Aggregation

Long/Short equity investing has underperformed for over a decade (see below). Worst of all, it hasn’t protected investors in down markets, when they’ve needed it most. Investors increasingly struggle to justify their investments in Long/Short managers. This is fixable.

Long/Short equity managers are stock pickers at heart. Many LPs ask them to do too much. They want high return and low volatility. To achieve low volatility, Portfolio Managers must become risk managers and diversify. Risk management is not a core competency of most PMs and diversification causes them to hold more names than they have the mental capital to manage.
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A growing group of LPs are recognizing that finding multiple great stock pickers with concentrated portfolios and creating their own risk management and diversification is the ideal strategy. Alpha Theory helped kick off this trend with their paper “The Concentration Manifesto” in May 2017.
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As mentioned in the paper, concentrated portfolios have better batting averages than diversified portfolios. The benefit is that the average return of the concentrated strategy is higher (2.1% vs. -0.1% after fees). The problem is that concentrated funds have the “red tail” on the left where there is a higher probability of large loss.

If you could invest in several of these managers (10 in this example) you can get the same return and cut off the left tail.

And if you could find 100 of these managers then…

There is tremendous potential in this structure for savvy LPs. In an ideal world, we would overlay this multi-concentrated strategy (+2.2% of return) with Alpha Theory position sizing (average improved returns of +4% per year) to create a vastly superior strategy that would pull investors back into Long/Short equity investing.

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