Sunday, December 9, 2018

Ochoa-Brillembourg, Delivering Alpha

Delivering Alpha: Lessons from 30 Years of Outperforming Investment Benchmarks (McGraw-Hill, 2019) by Hilda Ochoa-Brillembourg is written for “any finance professional who wants to know how to add sustainable value to globally diversified institutional portfolios beyond what’s learned in textbooks.” The author, after an 11-year stint at the World Bank as chief investment officer of its Pension Investment Division, was the lead founder of Strategic Investment Group in 1987 and continues to serve as its chairman. Since its founding, Strategic has outperformed its benchmarks more than 75% of the time on a rolling three-year basis with less volatility than the benchmarks.

Ochoa-Brillembourg is primarily concerned in this book with institutional portfolio construction and management. Although she acknowledges the many merits of modern portfolio theory, she writes that “in practice there is significant slippage between the practical lip and the theoretical cup. Principally, the optimal portfolio will change dramatically over time with the volatility of the assets it contains and the return and risk preferences of investors and securities issuers. Market variables are unstable, and most investors have significant risk and return constraints, forcing them to engage in exercises of ‘constrained optimization’ that will move away from the most elegant MPT concepts. Life is messy and hard, and so are optimal investment choices.”

She dubs her optimal portfolio construction theory “portfolio fit theory.” The process of improving the return to risk profile of a legacy portfolio (assuming that most assets in the portfolio are either worth preserving or inefficient to liquidate) involves adding marginal assets. “In this framework, the value of an asset needs to be assessed on the basis of its price, its expected return, its volatility of return—and, most important, its correlation with the legacy portfolio, not solely its correlation with the market portfolio.” And, an important corollary, the fair market price of an asset does not equal its value to a particular investor. “Certain assets may have a higher value to particular investors than their market price, and some assets can improve a legacy portfolio’s return-to-risk ratio and compound rate of return despite apparently suboptimal characteristics on a stand-alone basis.”

Ochoa-Brillembourg covers a lot of ground in this book, from selecting appropriate benchmarks to rebalancing versus tactical tilts, from the uses of volatility to the boundaries of risk. A sub-theme is governance. (It seems that her group has dealt with more than its fair share of clients who had less than ideal structures in place for making decisions.)

Delivering Alpha is brimming with the kind of practical wisdom that comes from years of experience in the trenches. Money managers of all stripes will profit from reading it.

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