Wednesday, August 23, 2017

Questions America Wants Answered: "What Is Idiosyncratic Alpha?"

A reference to idiosyncratic trading strategies was made in a market commentary by Neal Berger, the President of Eagle’s View Asset Management. In this article we attempt to clarify what these idiosyncratic strategies are.

Below is an excerpt from Neal Berger’s market commentary as reported by Matthias Knab (added emphasis is mine.)
In sum, we believe quantitative strategies still have a place in our portfolio. Traditional and more ‘pedestrian’ quantitative strategies such as fundamental factor, momentum, and mean-reversion based statistical arbitrage do not. We have already, or, are in the process of exiting those strategies and Managers who we believe run more pedestrian quantitative strategies that have not recognized or kept pace with the increased competition in quant and the reduction in available alpha due to the reasons mentioned above. While we are reducing quant broadly, within quant, we are increasing our allocation to strategies and Managers who run idiosyncratic and highly capacity constrained strategies that either require a highly specialized skill-set and knowledge to effectuate, or, are simply too capacity constrained to attract competition from the larger players.
The reasons mentioned for the reduction of alpha are primarily due to crowding effect in “pedestrian strategies” and less availability of dumb money to profit from. It was argued that a way out of this conundrum for some funds at least is through a shift to idiosyncratic alpha. 

Let us start with this definition:
idiosyncratic: peculiar or individual.

According to the above definition then, popular strategies, including trend-following, cross-sectional and absolute momentum, statistical arbitrage, including long/short market neutral, do not offer idiosyncratic alpha since they are widely known and are of high capacity. For example, CTAs are being already impacted by relying on high capacity and widely used strategies; alpha has diminished and CTAs are now trying to market these strategies in the context of low correlation with stock market and alternative beta; i.e., the past high absolute return potential is now gone, for good according to Neal Berger.

Therefore, we know what idiosyncratic strategies are not about. They are certainly not the strategies that are fully described in a few lines of code in some popular books. Below is an effort to identify a few of these strategies as the potential domain is large but difficult to fully research.

Idiosyncratic alpha strategies
Event and sentiment driven
Event-driven strategies attempt to generate alpha from corporate events that include mergers, acquisitions, earnings surprises, bankruptcies, CEO replacements, debt restructuring, to name a few.