AB’s Chief Risk Officer and Head of Quantitative Research shares his perspectives on the research behind the development of prime alpha.
We have to take risk to make money for our clients; we have to take risk [for the] research process and the investment process. So risk is not something to be avoided, but it’s something to be managed.
What you want to do is have a comprehensive framework, and you want risk managers who really understand the strategies that we have and tailor their approaches to the investment teams. This allows the risk managers to be creative in terms of how they interact with the investment teams. It allows them to really understand the nuances of what the teams do.
The idea is not that, you know, shocking. It’s something that’s intuitive to investors. By removing factor exposures like value and growth, investors understand that that isolates a manager’s skill better, so this idea is being embraced by the industry. What hasn’t been done is just the research and the rigor that we went through in our research to prove that this idea actually works.
I originally wanted to call this “idiosyncratic alpha,” but the marketers thought that was too “quant-y” and too geeky, and they said, “No, you cannot have that.” So I went back and I said, “What should I do?” One day I was eating in a restaurant and I ordered prime steak, because “prime” suggested a certain level of quality for the meat. And I said, “Perfect! This is exactly what investors are looking for: returns that they can eat.” Actually, no, what investors are really looking for are returns that are high quality and replicable. And that’s exactly what prime does; prime has that connotation.
I think in finance, the power that we all aspire [to] is to predict the future. Who wouldn’t want to know which market’s going to outperform, which stock’s going to outperform? So that’s a power that I want. Prime alpha gets me closer to that. It’s not a silver bullet, but it helps me identify the best managers out there and, therefore, hopefully help me predict what’s going to happen.
