Combining Best Ideas in Search of Alpha

Combining Best Ideas in Search for Alpha

A Good Idea Takes Time

Good ideas take time. In fact, one of the best ways to kill creativity is to act swiftly and decisively.

In a lecture delivered in 1991, British comedian John Cleese gave an insight into why some people are more creative than others and come up with better ideas.

Despite what you might think, talent was not the key ingredient in his framework.

Cleese recalled a colleague from his Monty Python days, who he thought was more talented than Cleese himself was, but yet struggled to come up with original ideas when producing new scripts.

“I watched for some time and then I began to see why. If he was faced with a problem, and fairly soon saw a solution, he was inclined to take it. Even though, I think, he knew the solution was not very original,” he said.

Time was the key ingredient missing from his colleague’s process. Like a good stew, you need to to let your ideas simmer in order to get good results.

Cleese didn’t advocate pondering endlessly about ideas until an original thought struck, but rather suggested setting a deadline for a problem and then start a process of productive procrastination before making a final decision.

“What I am suggesting to you is that before you take a decision, you should always ask yourself the question: ‘When does this decision have to be taken?’ And having answered that, you defer the decision until then, in order to give yourself maximum pondering time, which will lead you to the most creative solution,” he said.

Cleese’s thoughts on creativity are backed up by academic research from the late Donald MacKinnon, who was a professor in psychology at the University of California at Berkeley. MacKinnon discovered the most creative professionals always played with a problem for much longer before they tried to resolve it.

So if one good idea takes time, then a bunch of good ideas takes even more time.

How many good ideas can you produce as a typical investment manager at any one time?

Fabio Cecutto, Head of Global Equity Manager Research for Willis Towers Watson, believes about 15 to 20.

“How many good ideas can a single manager have? Is your 100th idea as good as your first idea? That is hard to believe,” Cecutto says in an interview with [i3] Insights.

Last year, Willis Towers Watson ran a survey of 977 global equity funds and found only 256 funds outperformed the benchmark after fees over a five-year period. They then looked at whether these outperforming funds shared any common characteristics and found these managers were typically concentrated and had long holding periods.

“When it comes to alpha, the types of managers that give you the best probability are concentrated, long-term managers: 15 to 20 stock portfolios with a long-term approach,” Cecutto says.

But for many asset owners, scale is a real problem and that is why Cecutto proposes combining up to 10 managers together in a portfolio of concentrated managers.

“If you bring together nine or 10 managers, you get a portfolio with 150 stocks and end up with quite a diversified portfolio. But what we see is that this portfolio of concentrated managers is far superior than getting a 150-stock portfolio from a single manager,” he says.

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You shouldn’t expect your whole portfolio to be adding value through alpha. Some scale is good, but too much can be detrimental to alpha

He acknowledges that even with 10 managers in a portfolio it can be difficult for the larger funds to get scale, but he says at the larger end of town it would be unrealistic to run entire equity portfolios on an alpha-seeking basis.

“You shouldn’t expect your whole portfolio to be adding value through alpha. Some scale is good, but too much can be detrimental to alpha,” he says.

“So you might have a part of your portfolio where you target alpha and it is almost like you are running a separate portfolio, while you have a large part of your portfolio driven by long-term factors.

“There you take an almost opposite approach, where you try to reduce idiosyncratic risk and try to get exposure to long-term factor risks.”

But he argues there needs to be a clear separation between the alpha-seeking strategy and the more passive, rules-based part.

“What works less well is an approach that blurs all of that together. It can become very difficult to separate the noise from the skill,” he says.

Convincing a successful equity manager to provide a portfolio of their best ideas at a reasonable cost can be tricky. That’s why Cecutto looks at particular types of businesses to partner with.

“We have a very specific type of manager that we are trying to pursue. So we have niche boutiques that are earlier in their life cycle. Quite often we go to managers and say: ‘We like your approach. Why don’t you create something more concentrated and bespoke than what you do?’ Maybe two, three years down the line they are able to market that as a new strategy,” he says.

“We’ve done that with a long/short manager in the US. We worked with them on a long-only portfolio with 15 of their best ideas. So we are able to work with them and they see us as almost a strategy partner.”


[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.