Positive Alpha Generation
Designing Sound Investment Processes

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The foundation for creating sound investment solutions has been laid out when Markowitz introduced in 1952 the concept of modern portfolio theory in his seminal paper called Portfolio Selection. The full significance of the relationship between return and risk, and with it, the effects of diversification, was articulated. In the following years numerous models of financial markets, like the capital asset pricing model or the arbitrage pricing theory, have been developed. A large number of theoretical as well as practical toolboxes have been introduced that directly or indirectly allow enhancing the quality of investment solutions.

But few has been written on combining these investment models into successfully investment products and especially customized solutions. In this book I take an engineering approach to portfolio management. I present the different models and toolboxes that have been developed in the past and compare their strengths and weaknesses. I especially focus on the process of combining them in order to build sound investment processes. Both modeling as well as organizational aspects are addressed.

Successful investment managers differentiate themselves along four key dimensions, that is,

  • they deliver the promised performance, whether relative to a benchmark or absolute,
  • they implement an investment process that is cost efficient in production, but flexible enough to satisfy the specificities of the investor's needs,
  • they offer a transparent and trustworthy investment management approach, and
  • they provide innovation in order to understand and best satisfy the investor's needs.

This book is about showing how an investment manager can provide investment solutions that maximize his opportunities along these four dimensions. Delivering the promised investment performance is essentially driven by the investment manager's forecasting skills. I describe techniques that can be used to develop these skills in a consistent manner and combine them to leverage their impact. I strongly believe that cost will become an even more important differentiating factor in the future, especially with the introduction of new pricing models. A very promising approach to achieve cost efficiency, especially when dealing with a large client base, is the value chain approach or a variation of it, like value nets. The different constituents of an investment process, called modules, are presented throughout this book based on the value chain approach. From an investor's perspective, buying an investment solution or entering into a contractual agreement with an investment manager, is accepting a promise into the future. Especially when the investor is not the actual owner of the funds, but only its trustee, it becomes very important that the proposed investment solution is transparent to a degree that the investor is capable and willing to trust it. This can be achieve though three elements, that is, a structured investment process that can easily communicated and understood, a clear definition of roles and responsibilities, and a quality or performance management approach. Finally innovation can only be achieved if the investor's needs are well understood and translated into investment solutions that can be produced with the available skills.

I describe in this book numerous techniques to achieve investment management success. They are based on the experience of colleagues and me through designing and implementing numerous investment processes. But they are only examples and should be considered as such. It is the role of each investment manager to combine and adapt the proposed techniques so that they fit with his individual needs and are based on his specific skills. My goal with this book is achieved if I have provided the reader with ideas that he has not yet thought of or has though of from a different perspective and that he believes could be relevant, or at least interesting, to adapt and implement in his own environment.


Please note that the excerpts published here are © 2009 by John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, England. They have been published here with their permission. Any use other than to form an opinion on whether or not you should buy the book is forbidden.