One day around 1300 BCE, some bored Phoenician farmers came up with the first letter of their alphabet – alep – basing it on their word for “ox", the animal they depended on to do all the heavy pulling. Filter that through Hebrew, ancient Greek and Latin, and you eventually get to the modern term alpha.
Fast-forward to the 21st century, and we have the all-too familiar concept of financial alpha — essentially, the 'excess' return you get on an investment over and above that of its benchmark. But in a world where generating financial alpha alone may not be enough to keep the doors open, asset managers need to be looking to operations to maximize profit-making opportunities.
What Is Operational Alpha?
The term "operational alpha" is less widespread, but it's picked up steam in recent years. Northern Trust has described it as the positive impact of “data aggregation, historical analysis, custom tagging functionality, and on-demand or real-time data retrieval" on investment strategy and operations.
Simply put, it's a way of thinking about culling out inefficiencies in your operational processes to minimize resource leakage and maximize the power of your technology. And it's an especially important mindset in the current environment. With regulatory demands rising, fees being squeezed, and trading itself become increasingly complex, hedge funds are being asked to pull like oxen – while looking like racehorses.
Hotspots of Inefficiency
It all goes back to some of the areas of concern I wrote about when this blog was starting out:
- Data management. Many of our clients come to us with the problem of how to centralize and consolidate pulling data from various parts of their business processes together. Being able to put together a clear picture of results from disparate data sources quickly enables asset managers to move in tandem with the market from the best possible position. This is especially true for smaller managers, who may not have an army of data crunchers reconciling Excel spreadsheets and feeding results back to the desk.
- Increasingly complex regulation. With MiFID II and a plethora of other regulations impacting the market, much time and resource is spent on complying with regulators and reporting to regulators. If the majority of your staff is focused on these necessary day-to-day tasks, this leaves little time to think about broader strategy.
- Trading complexity. Financial firms need a platform that can handle a wide range of asset classes equally well, including trade execution with multiple third parties. Just as compliance and regulatory failings must be avoided, trade breaks can cost money as well as investor trust.
- Overall tech infrastructure. Most firms have legacy systems that aren't scalable and don't talk to each other; these can be pricey to either fix or “rip and replace". The CEO of one of our smaller clients tells us he relies on Eze's technology to keep his operation “lean," allowing him to invest the firm's “human capital" in strategy analysis and risk mitigation. We hear similar things from our big clients, too.
The Alpha Wolf
In a sense, operational alpha seeks to extract “hidden" or “extra" financial alpha from operations. The concept lies at the core of what we do: permanently replace weeks of effort with the click of a mouse. If a firm can successfully generate both financial and operational alpha, it's that much closer to becoming, well, the alpha wolf of the pack.
Of course, defining operational alpha inevitably begs the question of how to actually measure it. We'll be diving into that in a few weeks; stay tuned, and subscribe for updates.
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