The Return Of "Alpha" According To BlackRock

Amanda Cheesley Deputy Editor September 5, 2023

The Return Of

A senior investment figure at the world's largest asset manager discusses how changes in the investment environment bring about a return of "Alpha" opportunities or excess return for active stock pickers focused on company fundamentals – a debate that never seems to end. And AI makes an appearance.

The post-global financial crisis (GFC) period of easy money is over and markets after the pandemic are more volatile, creating more differences between stocks' behaviour, opening the chance to find market-beating returns, BlackRock says.

“One implication of this new investment regime – which is characterised by higher inflation, rates and valuations – is lower market returns, or Beta, suggesting a higher portion of equity portfolio returns will need to come from Alpha,” Helen Jewell, chief investment officer, BlackRock Fundamental Equities, EMEA, said in a recent note. “This new backdrop presents a different set of opportunities for equity investors.”

Alpha represents how much an investment's actual return has exceeded its expected return, based on its risk level. Alpha is used to evaluate whether an investment has outperformed a certain benchmark. Beta, on the other hand, measures how volatile an asset is compared with the overall market.

For years, debate has raged on whether it makes sense to pay active fund managers a fee to find this Alpha, or ride the market by tracking an index and capture the Beta instead. When stocks rose on a sea of cheap money after 2008, Alpha strategies fell out of use and fees for active funds became harder to justify. Tighter regulations on advisors' fees also encouraged the shift to more "passive" investing. With central banks raising rates, however, the ability to find gems amid the market noise is once again back in fashion.

Jewell identifies five factors driving the case for a return to alpha-centric investing.

Firstly, volatility is more likely to increase than decrease, she said. “Geopolitical concerns, supply disruptions and data-dependent central banks committed to fighting inflation are likely to stoke bouts of volatility across time. The market dips inherent in volatility can lead to mispricing, presenting opportunities for active stock pickers to purchase shares of companies with good prospects at a discount,” Jewell continued. She sees opportunity for Alpha in cyclical stocks which are typically punished in a recession, that may be discounted beyond what their fundamentals suggest, or may be pricing in a deeper recession than she believes likely.

Secondly, Jewell thinks stock dispersion is normalising: “During the GFC, stock dispersion was muted, with little difference between the best and worst performers. The beta-driven market environment of the time meant that there was little advantage in identifying the winners or avoiding the losers.” However, she sees dispersion in earnings, valuations and returns increasing in the post-pandemic period, setting up an environment in which skilled stock picking can provide a more meaningful contribution to portfolio outcomes.

Thirdly, Jewell thinks that stock specifics are gaining influence: “Our analysis shows greater dispersion in returns is increasingly based on stock-specific variables and less on the factor characteristics of the stocks (e.g., growth vs. value, small vs. large), which were more dominant in 2020 and 2021.” She believes that active selection focused on fundamentals can have a greater bearing on investor outcomes under these conditions. Jewell also expects to see investors increasingly shifting their focus away from macro concerns at large to seeing how individual companies are coping with an environment of slower growth and higher inflation and rates, making company specifics more important to investment decision-making.

Fourthly, Jewell believes market breadth is poised to widen: “Market breadth is historically narrow, with 22 per cent of the S&P 500 Index’s market cap attributed to the top five stocks. This compares to just under 16 per cent pre-Covid and 13 per cent ahead of the GFC, according to Refinitiv. Comparing the index’s market cap-weighted and equal weighted returns illustrates just how much certain mega-cap stocks primarily tech-related shares across IT, telecom services and consumer discretionary, have driven index performance in the US this year.” 

As the market increasingly acknowledges and values company fundamentals, Jewell expects market breadth to widen beyond the current leaders and create greater opportunity for active stock pickers focusing on company fundamentals.

Artificial intelligence impact
Finally, given its immense potential, Jewell sees artificial intelligence (AI) contributing to increased stock dispersion. For example, the winners among software companies will successfully incorporate AI into their products and be able to raise prices, while those that fail to do this will become outdated.

“The impact is not limited to the tech sector,” she added. Across industries, Jewell expects that new business models will arise, powered by AI innovation, and others will be disrupted (e.g., call centres where humans are displaced by chat bots). In her view, understanding AI use cases, implications and risks across sectors, industries and individual stocks will have an increasing influence on investment outcomes.

In this new investment regime, Jewell thinks supply is being constrained by demographic trends – ageing populations and fewer workers, deglobalisation and decarbonisation, all of which are inflationary as companies spend to adapt. “Developed market central banks are now more likely to be in a position of having to fight inflation rather than bolster the economy,” Jewell said.

Equities historically have been the highest-returning asset class over the long term, which she expects to continue. However, higher stock valuations and higher interest rates mean lower market returns more broadly (beta). Jewell sees more dispersion in earnings' estimates, valuations and stock returns and this represents a greater opportunity for skilled managers to generate more alpha. Jewell expects that the years ahead will see active return being a bigger part of investors’ overall return profiles.


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