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This is a weird question - how do specialists produce alpha?
I think specialists often struggle to generate outsize returns b/c they work in a more limited space and have a constrained view of the possibilities.
If your question is how do you find decent ideas: macro trends, friends, sellside, other hfs holdings/ letters, conferences, etc.
Warren Buffet
I'm a generalist and run trades for both a global macro strategy and a long/short US equity strategy. My general strategy is to "bet" on economic outcomes. Sometimes, those economic outcomes will impact a sector or industry more than others. Within that sector or industry are companies that may be more or less sensitive to that outcome. I would then look to find the most efficient instrument to make that "bet"-- be it currency, rate, or equity (or equity derivative). My trades are typically market neutral, so my alpha is not "crazy high", though my returns can be very high (a la margin or derivatives). Pure alpha tends to benchmark against short-term rates anyway, so it's important to distinguish alpha from returns.
Thanks for the post, seems like an uncommon role so I hope you don't mind a few more questions.
By market neutral do you mean: - long equity vs short commodities - long energy vs short financials - long E&Ps vs short services - long Exxon vs short Chevron
I think what the OP is getting at is, how does someone in your shoes get confidence they can outperform the sector specialists looking at each area with more effort and granularity than you can afford? What is your edge?
I would have guessed something like the ability to rotate between sectors and industries nimbly to capitalize on the cycles within each vertical. You only have to get the industry call correct, perhaps an easier hurdle than calling one company versus another in the same industry (as sector specialists often must do).
Do you have a codified, repeatable process? How did you go about building your knowledge base of such a wide spread of industries/companies to the point of knowing which companies would outperform others in the same industry in a given macro scenario? How do you adapt/alter your knowledge base to incorporate new information e.g. this company used to outperform another in this macro scenario, but that pattern is different now?
it takes many years of experience, usually working under somebody who teaches you, to get good at this sort of thing. you would start out as a junior analyst working for somebody who is doing this (doing their grunt work)...and over the years you would learn how to do it yourself.
Market neutral traditionally means 0 beta exposure to a selected benchmark. In my case, being market neutral means having a portfolio beta (against US equity) of close to 0.
Generalists vs. specialists can be better understood through understanding the process-- top down vs. bottom up. In regards to having confidence to outperform versus specialists, as others have commented, it is in getting to see the larger picture across multiple sectors, factors, or asset classes that, in my opinion, establishes an edge.
I have repeatable processes that are linked to specific scenarios. As for your question about finding the right companies given the macro scenario, that's where quantitative analytics comes in. I track indicators, financial metrics, and other information to generate signals. These "signals" decay quickly, and so the analytics needs to be generated frequently. With the right signals, putting together a short-list of companies is quite easy. The next step is due diligence, valuation, and then setting a risk framework.
The sell-side (and experts) does an amazing job of capturing qualitative information, industry level information, and additional nuances/rumors about companies. I learn a lot about the industry and companies through them. But I don't pay too much attention to their trade ideas as they're typically lagging or not right for my strategy.
Hey I'm gonna shoot you a PM.
It depends on how you define a generalist.
If Warren Buffett is a generalist, then the argument could be made that long term investing generalists have a fundamental belief that an investment thesis produced by them is accounting for qualitative information that is generally (ironic use of word) not quantifiable.
Can you perfectly quantify Warren Buffett's methodology? Good luck.
Therefore, my argument has always been to not seek out generalists to emulate because they are generally not easy to replicate.
No, if you are a generalist you don't all the sudden abandon all quantitative factors around an investment.
The point is WB has a deep understanding of real estate, industrials, insurance/financials, etc. since he has been studying the market so long. He's been investing over a time period that can easily be the time period of 2-3 other investment professionals careers put together.
Can you perfectly quantify anyone's methodology? Good luck.
I agree that being a successful generalist is normally difficult
You can quantify a quant fund's methodology much more than you can quantify a generalist's methodology. Nothing in life is perfectly black and white, but there are ultimate shades of grey.
There is a reason why Dalio's Principles is such a hit. It is something we can all admire and emulate, because it is something you and I can do.
It’s also been a while since Buffett had alpha.
Scale and aqr somewhat killed him.
But he’s also a genius. The he buys cheap stocks and holds them long term though is crap. He’s definitely evolved a few times. From cigarette butts to basically being the first guy to figure out low vol stocks outperform.
He is also a genius as an operator.
He’s also a huge hypocrite. On taxes. On being “folksy”....he’s had a ton of mistresses. His public persona isn’t necessarily how he behaves. Which I also think makes him a genius. Great PR manipulator.
Typically, for any sector, there are 2-3 key drivers that will move a stock. In retail it might be LFL sales, for banks it might be NIM and loan growth. As a generalist your job is to (i) identify what those key drivers are, and (ii) take a view on those key drivers. A lot of your time is spent talking to the sell-side to understand different view points, and using your judgement to decide who on the sell-side is right.
I will give you an example. Going into 2018, most European sell-side banks analysts were projecting bank NIM's (net interest margins) to increase as the ECB announced the end of QE and core inflation started to creep up. The thinking was that interest rates might (finally) rise and banks would benefit from this. Fast forward to the end of 2018 and the SX7P is down 28% YTD as analysts have adjusted down their earnings estimates on the back of weak inflation numbers and no sign of rate hikes any time soon.
As a generalist, all you had to do (easier said than done) was understand what was driving consensus and fine a compelling view either for or against that consensus. A good generalist knows that he will never understand the sector as well as the specialist, but he adds value through superior assessment of risk/reward. If you're a generalist and you can't develop a good grasp of risk/reward analysis you won't last long in the business.
What is the barrier to entry that prevents sector specialists from developing the same level of skill at assessing risk reward as a generalist?
I would assume in every sector there are at least a few specialists that are great at assessing risk reward, plus they have the deepest knowledge in their respective sector. What is left for the generalist?
Not trying to be difficult, genuinely trying to understand. Thanks
it takes a LONG time to develop this macro economic skillset..there are so many data points to consider, and you never know which one is the more significant driver until it peeks its head out. In 2007 it was mortgage lending (i recall my aunt buying a house in florida at the peak as an "inflation hedge" and then she got smoked as the house value dropped by 50%....its always easy in hindsight...harder before the storm hits to go against concensus view...remember concesnus comes from lots of "smart" people who eventually are very wrong)...in 2000 it was the dotcom bubble...the story just keeps going.
So, what economic data today is going to drive the next big move, and who is on the wrong side? NVidia was going to the moon, until the chinese clamped down on crypto, and then all of a sudden, there was no need to buy all these graphics cards.
Good question. What I tend to find is that as a specialist you run a higher risk of missing the big picture and getting caught in paralysis by over-analysis. Also, there tends to be a high degree of group-think within the specialist community. As a generalist you are approaching a stock as an outsider so "in theory" you can look at a company without any pre-established bias. The other benefit you have as a generalist is you will have seen many different companies in other sectors so you will have a broader set of experiences to feed off when you approach a company.
One other advantage I find is that you don't feel the need to find value in a stock or sector as a generalist. Ask any specialist and he will always have a great long idea in his sector, even if his sector is overvalued. As a generalist I can avoid entire segments of the market if I don't see any value there.
Well said Ovechkin.
People also assume specialists will be better able to identify when concensus might be off. One has to keep in mind that consensus is typically being formed by the specialists. What generalists can often bring to the table is a broader perspective informed by having invested across multiple sectors.
well said!
Insider trading/government corruption
Here’s what I don’t get, the markets been in the shitter these last 3 months and now all of a sudden it seems everyone has view on the macro
I was always under the impression that the macro is going to do what the macro is going to do and you just want to be positioned in names that have idiosyncratic stories with runway vs. the global economy is crap so let’s pile into defensive sectors.
I think the generalist is more like to do this vs. a specialist but I could be wrong
So true! Half our "we are stock pickers" PMs are now Fed whisperers, experts on Chinese socioeconomics and politics, and/or yield curve experts.
If you do 20 calls on an industry and read everything on it then you can be a sector generalist and outperform. Markets are not efficient and most people don’t understand the businesses they invest in deeply.
@Rahma - thanks for your excellent insight.
Would you say your style is similar to Scott Bessent?
Also, what was your pathway to PM?
SB in advance.
Ovechkin08 brings up fantastic points with regards to seeing "the big picture" and avoiding sectors that are overvalued. However, I'd like to correct this misconception that Warren Buffet is a generalist. He is not. Let me also clear up the idea that a specialist only focuses on one space. You can have deep specialist expertise in 3-4 spaces, it's just very, very rare due to the skill you'd need to have. For instance, I can specialize on pharma and software. Simply because it is more than one space doesn't imply that you're a generalist. A generalist would cover roughly at least 30-40% of spaces with relative frequency.
He is a specialist who has made 80-90+% of his money in 4 industries: consumer nondurables, finance, insurance, and media. He dabbled in a few other spaces in his younger days, but doubled down on these areas after experimentation and built nearly all of his wealth here. Since this does span a variety of industries, people tend to think he's a generalist. For a great analyst (not as good as Buffet), being a specialist in 2 of those spaces would be more than enough for a successful career. WB is ungodly good that he can specialize in 4 industries. At the end of the day, I'm of the firm opinion that it is the specialist, with expertise across at least two industries (located in different sectors) that has the best odds of generating alpha. Having two+ areas means you have the big picture view, and can juggle between the two depending on if one is overvalued as a space. My two cents
What his media play? I agree with just about everything else; maybe I’m being an idiot but I can’t see what he’s doing in media.
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