How do generalists produce alpha?

maddy.ap's picture
Rank: Monkey | banana points 63

Any generalists out there, how do you produceb alpha when you don't even have expertise in an industry or lots of experience in that space?

How do you narrow down on an investment that would deliver long term returns?

Comments (56)

Dec 16, 2018

BUMP

Dec 16, 2018

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.

Dec 17, 2018

Warren Buffet

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Dec 19, 2018

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.

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Dec 19, 2018

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?

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Dec 19, 2018

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.

just google it...you're welcome

Dec 20, 2018

This is very true. Learning from others is incredibly important, especially for things like trading and developing your instinct.

I would just add though that it's also incredibly important to be a self-starter and to have the initiative to figure things out for ourselves. Be very curious about the world and seek truth.

Dec 20, 2018

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.

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Jan 19, 2019

@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.

Remember, the grass is always greener on the otherside because it's fertilized with bullshit.

Jan 11, 2019

Hey I'm gonna shoot you a PM.

Dec 19, 2018

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.

Array

Dec 20, 2018

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

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Dec 20, 2018

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.

Array

Dec 20, 2018

I disagree. Warren Buffet buys companies at low multiples that generate attractive cash flows. Okay please now explain to me what 10,000 lines of codes are doing in a quant fund.

Dalio's Principles are a hit because people are obsessed with how weird the culture is and since he's at the helm of the largest hedge fund in history there is a lot of public coverage about him...and no you and I (or even Bridgewater) cannot perfectly emulate all 200+ of those Principles. Also, even if you do, those are more of living principles, only a few people at that firm even have an idea of how their black box works so good luck figuring it out.

I'm assuming your name is Raghu Kumar (hints your username), since in your one post you brag about your incredible returns (sharpe 3+ and having almost no losing months) and point to a forbes link, but in that link I find "Two years of full-time work earned them around $20 million; it also gave them the confidence to start a hedge fund. However, the 2008 crisis hit them hard; no algorithm could help them crack the US markets. It was time to shut shop and take a break." Feel like you might actually just be a troll.

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Dec 20, 2018

You might be surprised by how simple and transparent systematic investing can be. There is a lot of data munging and aggregation but the return forecasting models can be surprisingly straight forward.

Anyway, I think what is meant by quantifying the methodology of a quant fund is that it is very easy to change an assumption or aspect of the model and see what the result would have been as you can just rerun the model with or without that assumption/aspect and see what securities would have been selected. In that sense you can transparently quantify the effect of different parts of your methodology.

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Dec 20, 2018

Sure, I'd agree that backtesting is more applicable/easy at a quant shop vs. fundamental.

But, the equivalent would be have Buffet's entire portfolio and then saying, "in retrospect if we removed these X number of investments, this would have been our fund return outcome." I think that it's hard to compare apples to apples so don't have much more to say other than I understand the point you are making.

Dec 20, 2018

Lol you think I'm a troll based on a Forbes article? :)

Elaborate, please?

Array

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Dec 20, 2018

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.

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Dec 21, 2018

How is he a hypocrite on taxes?

Dec 21, 2018

He complains about low taxes in the rich. While he's structured himself to pay little taxes regardless of the rate.

Array
Dec 27, 2018

That doesn't make him a hypocrite. He's simply proving how broken the system is...he's literally saying one thing and then showing how that plays out. He's pretty much the opposite of a hypocrite

Dec 27, 2018

He's never advocated higher taxes that he would pay. He's advocated higher income taxes primarily. Ceo pay. Not capital taxes.

Array
Dec 27, 2018

https://www.cnbc.com/2017/10/04/billionaire-warren...
Stating that he does not think the new tax framework that eliminates the estate tax would probably be smart. That tax is not an income tax. This is also after a very quick Google search.

You write a lot of insanely inaccurate, definite statements and might want to read/research first....

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Dec 27, 2018

I believe his endowment is structured towards reverting to his family after 20-30 years so to avoid estate taxes

But regardless on tax rates the primary debate was on ordinary income - guys who do pay a lot more in taxes than their secretaries - while claiming the debate was on the rich paying less than the poor. Which was patently falsely. The already rich pay less. The Goldman Sachs managing director in nyc might have been paying 45-50% of their income in taxes. So there was deep hypocrisy that he was aware of.

Also he tries to come off as folksy and small town values.

Or his lectures against derivatives as wmd. When he has a giant book of derivatives.

On taxes it was a reference to older tax debates where he failed to differentiate between capital and labor income. Which are much different rates and hypocrisy through omission.

Array
Dec 28, 2018

You are basically saying, oh my statement about taxes was just about some old thing don't take what I said first seriously.

What the the deep hypocrisy you are talking about? A GS MD is going to be paying more in income taxes than his secretary hands down. If you are saying the discussion is about income taxes, then you are not realizing how income taxes work or should learn how to write clearly.

Again for your derivatives point, if they exist and he can legally take advantage of them he's going to and the fact he does is what makes him hilariously smart/a good long-term investor.

Not worth arguing, you obviously have your views.

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Dec 28, 2018

You are wrong. During the Obama tax hikes he was quoted as saying "he shouldn't pay less in taxes than his secretary". The primary tax hikes were on high ordinary income folks. Thus hypocrisy as he made it sound like he was advocating taxes on people like himself.

I don't question his genius. I just wouldn't believe a word he says publically.

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Dec 28, 2018

I am not wrong, you cannot understand anything. He pays less in taxes than his secretary cause he takes no income and it's all investment income. If that is the exact situation (you obviously could have misunderstood), then he is actually 100% advocating taxes on people like himself who aren't high earners and have a ton of investment income. HE IS SAYING THE EXACT THING YOU SAY HE IS NOT SAYING.

You are so incredibly dense.

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Dec 28, 2018

Then why did he pound the table for higher taxes on ordinary income? While using himself as an example....someone who pays no taxes?

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Jan 8, 2019

Brilliant point about the identification of low vol. Knew about his evolution but never thought about it that way before. Am curious how he formulated that in his head as he probably wasn't thinking "low vol."

At the risk of getting attacked by @Excelling - Buffett continually bad mouths activists and hedge funds, he was the first activist and ran one of the earliest hedge funds

I don't think you need to completely discount anything he says publicly but his shareholder letters are very open with what he does (including his giant book of derivatives.)

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Dec 20, 2018

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.

Dec 20, 2018

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

Dec 20, 2018

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.

just google it...you're welcome

Dec 20, 2018

2007 was oil. Everyone gets that wrong. It made the fed position for inflation and they missed the rapidly slowing economy. It had them hiking as the mortgage market was blowing out.

If they had reacted in real time the mortgage meltdown would have been limited to the subprime market and would have just been a dip in the economy.

But the fed was way behind the market and instead of liar loans blowing out every loan blew out because no one had jobs.

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Dec 20, 2018

nope...if you recall, in early 2007, the fed said "pockets of housing are weak, but the overall market is still healthy"....they said that during the height of the subprime dumpster fire...they had no clue about the scale of the loan fraud that was going on...and when a few people tried to tell them, they put their head in the sand and waved them away....stupid plebs.

also, there was inflation...HOUSING INFLATION (which cascades to everywhere)....caused by all that fraud. The Fed decided to pop that bubble. Boom goes the dynamite.

High oil prices are a cost to the economy (because oil is consumed)...they don't cause general wage inflation (outside that industry, which is a small % of the economy). High housing prices cause actual inflation...people wealth increases, which raises all prices..that's the inflation the Fed fears.

just google it...you're welcome

Dec 20, 2018

I think it was both.

I think people underestimate how important oil was in 2008. It was over $100 most of the year and peaked at 160. If for no other reason than psychology it gave the fed a strong signal the global economy was strong. Which kept them more balanced instead of attacking the housing market with aggressive rate cuts earlier in 2008.

The big issue with 2009 is the fed got on the wrong side of the curve and they ran out of ammunition until they invented large scale QE.

Subprime mortgage meltdown is nothing when the fed realized they have unlimited ammunition.

QE beats all. Solved the European debt crisis.

Array
Dec 20, 2018

Oil spiked in 2008 because of the EUR/USD (overlay a chart of EUR/USD with CL futures to see it....EUR moved first....CL confirmed after). If you want to argue cause/effect...look at this year....EUR made the move first...and then crude followed 5 months later.

oil vs EUR

its a messy correlation...they both overshoot...with lots of volatility (this looks like a great pairs trade btw)...but i would argue FX drives rates more than oil.

just google it...you're welcome

Dec 20, 2018

I wouldn't trade those. Obviously correlated since dollar overall is one of the three big inputs into oil prices.

But I'm not sure how your chart disagrees with what I said. I said oil (or you could replace that with weak dollar) slowed down how quickly the fed responded to weakness in housing.

The key thing for the fed isn't to bail out dumb speculators. It's to stabilize the broader economy and prevent spillovers.

Weird we both see a recession. I see a preventable recession. It's really stupid to have a recesssion because you hiked rates too much when the market is telling you rates are high enough.

Array
Dec 20, 2018

why wouldn't you trade those? they seem pretty obviously correlated....with lots of volatility?

just google it...you're welcome

Dec 20, 2018

Correlation breaks down.

It could let you isolate supply or demand in oil and factor out dollar.

Array
Most Helpful
Dec 20, 2018

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.

Dec 20, 2018

^in your 2 posts, you have articulated the answer better than all others thus far, agree with it all +1 SB

Dec 20, 2018

I don't buy this argument of "over-analysis." More knowledge is never bad - and the idea that you know "too much" to make a good decision seems like a bit of a cop-out.

Also, a generalist is just as prone to the opposite issue of missing crucial pieces of information that isn't readily apparently to non-specialists who've followed the space closely, in the same way that a junior analyst in any sector/generalism is prone to missing things that an experienced PM or senior analyst can point out in 30 seconds.

Also, what prevents a sector specialist from straight up shorting his sector if he sees overvalue? Or pair trades? Relative long/shorts? Etc. etc.

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Dec 20, 2018

"More knowledge is never bad" - Agree. This is why I originally said the OPs question is "weird". For the most part, generalists generate alpha the same way specialists do, so the question immediately turns into: "what do generalists do better than specialists", which is what @Ovechkin08 tried to answer.

The best specialist in a space will tend to be better than any generalist. However, generalists can compensate for this, like Ovechkin implied, via increased flexibility. Being a genius in any one sector is useful when there is significant fundamentals based dispersion (I'm thinking from perspective of fundamental investors here, traders are a different story) in that sector. However, if there's nothing going on in your sector you're S.O.L.

In my experience the best investors are semi-generalist. They're good enough within 2-3 sectors to get 90% of what the specialists do but also flexible enough to switch sectors and pick up new coverage on the fly. If you're a medium - long termish investor the 90% is more than enough to generate real alpha. At any given time you might not know everything that's going on in the sectors you're not focused on, but if someone pitches you a compelling idea in one of those sectors you can quickly pick it up and evaluate.

Dec 20, 2018

Reasonable response. But, I wonder: given how structurally challenged the industry appears to be, are we soon approaching a point when 90% isn't enough? The "easy money" is long gone seems to be the consensus. Doesn't that bode poorly for generalists? We might soon move to a paradigm where investing is dominated by fundamentally ignorant investors (algos, quants, etc.) and extreme specialists, with little room for anything in between.

Dec 21, 2018

The difficult part is that a lot of funds that train/ value a generalist skill set are dying. The AUM in the industry is increasingly moving towards platforms that value ultra specialization (not just "Tech", but "Asia Internet" or "Western Europe Telco").

I actually think there is less and less alpha in thinking your in-depth understanding of a small group of stocks will allow you to out-trade people in the short term. Market regimes move quickly, with different sectors moving in/out of favor. Being able to go where the opportunity is will be more alpha generating going forward - provided you can find someone that will pay you for the skillset.

Dec 20, 2018

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.

Dec 20, 2018

well said!

Array

Dec 20, 2018

Insider trading/government corruption

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Dec 21, 2018

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

Dec 22, 2018
Dazed_Iam:

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.

Dec 21, 2018

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.

Jan 5, 2019

@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.

Remember, the grass is always greener on the otherside because it's fertilized with bullshit.

Jan 11, 2019

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

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Jan 11, 2019
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Jan 11, 2019
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Jan 11, 2019