Taking a Multi-strategy Approach to Alternative Investment
When it comes to corporate strategy, I have long been in favor of more focused, single-purpose enterprises than those which take a conglomerate approach. The reason: I find the benefits of centralized management largely illusory and only introduce friction to the operation of a portfolio of businesses. Sure, there might be cost savings both in financing and materials purchases through conglomeration, but in my book these benefits are generally outweighed by lack of focus and bureaucracy. For every GE, Danaher and Berkshire Hathaway there are literally hundreds of businesses whose diversification efforts failed and destroyed shareholder value. Give me a bunch of good, focused businesses with great management and I’ll do my own diversification.
This contrasts with my view of investing. Focusing on a single asset class, regardless of how expert the manager may be, exposes the investor to either poor returns with low uncertainty (e.g., investing in Treasuries) or unacceptably volatile and lumpy returns (e.g., investing in commodities or the emerging markets). This is clear. But what about when a particular manager seeks to invest across an array of strategies, much as a conglomerate invests in a group of different businesses? Does the same “friction” argument hold that renders the multi-strategy business structure so unappealing? Done well, I think not.
The difference between a conglomerate manager and a multi-strategy hedge fund manager is clear to me, but there are some caveats. Few conglomerate managers have an intimate understanding of all their business lines, and certainly not to the depth of those managing single-purpose businesses. Balancing the administrative benefits of conglomeration with the costs of bureaucracy and foregone entrepreneurship within the individual businesses is an extremely difficult and complex dance. Conversely, an investment manager who uses their expertise to employ a range of strategies (say, long/short equity, distressed and convertible arbitrage) gains the benefits of opportunism without the costs of straying from their core competency (in, say, deep fundamental analysis).
I think the argument breaks down when managers go outside their skill sets, trying to operate like a multi-strategy when their team lacks the skills and experiences necessary to do so. So multi-strategy approaches that offer diversification and flexibility without the give-up in quality are particularly well-suited to the currently challenging and uncertain market environment. In fact, I’m not sure I can think of an environment where this approach is less appealing than a single-strategy model. Top alternative investment asset allocators (think pensions and endowments) may argue that they prefer single-strategy funds, and want the ability to allocate among the strategies employed by multi-strategy funds (as in the example above, they’d want to invest in best-of-breed long/short equity, distressed and convertible arbitrage managers separately). But this approach doesn’t take into account a two important points: the ability of a top manager who is living the markets every day to make superior asset allocation decisions, and the benefits of learning that are available across a multi-strategy team. These are two powerful sources of value that are not available to the asset allocator with single-strategy funds.
But the perils of growth need to managed very carefully. As a multi-strategy fund grow, there may be times when it makes sense to run it as a portfolio of strategies (much like DB Advisors, Millennium and the like), giving the manager the ability to asset allocate based upon market conditions while providing the individual teams with more closely aligned motives than what existed in the massive single-team, multi-strategy approach. These are hard businesses to manage but with the right culture and incentive systems it can be done. But with the promise of attractive risk-adjusted returns across a wide range of investment environments, the trouble is worth it.
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COMMENT:
AUTHOR: Dave
EMAIL: frieddave@gmail.com
URL:
DATE: 03/30/2008 10:32:10 AM
Didn’t the original supporters of corporate diversification claim to have gotten their inspiration from Markowitz’ work on modern portfolio theory?
In any event, I would agree with you that corporate diversification is a different beast than diversification of financial assets. Managing a diverse line of businesse entails not only managing the businesses themselves, but also the people in those businesses. When you have large firms like Citigroup, convincing wealth managers at Smith Barney that they should work with the investment bankers on Greenwich St. for the (alleged) benefit of their wealthiest clients is at best hard, at worst impossible. This same thinking applies for non-financial firms, as well.
As for GE, well, in a 10 year period, their stock is up a grand total of 35%. Doesn’t really seem that bolting NBC on to what is essentially a consumer finance company, with a couple of industrial adjuncts, makes for a stock that performs well.
But how does all this tie to your arguments about holding various financial assets? Financial assets are mathematical abstractions, not lines of businesses rife with internal and external conflict.
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AUTHOR: Yaser Anwar
EMAIL: yaser@yaseranwar.com
URL: http://www.linkedin.com/in/yaseranwar
DATE: 03/31/2008 03:20:17 PM
Your post two years ago pertaining to this topic was great http://www.informationarbitrage.com/2006/07/broadening_the_.html
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