By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Every investment management organization believes that it has some secret sauce that provides their investment process with the ability to consistently add value. If that were true, one would think that the special insight(s) would be carefully guarded. Yet, I see on a fairly regular basis emails touting various investment insights from one firm after another. Why? In an investment landscape that has proven to be incredibly challenging for advisors to actually add value relative to stated objectives, the sharing of one’s secret sauce seems detrimental to one’s ability to consistently add value.

In a previous life, I was the head of Invesco’s quantitative equity business (roughly $30 billion in AUM). I was extremely fortunate to work with and learn from so many incredible investors. Our fundamental ideas were implemented in a systematic fashion as we attempted to remove as many biases as we could from the investment process. As good as our insights were, they didn’t always work in every investing environment. We would monitor our indicators on a regular basis to make sure that the forecasting ability of the insights wasn’t deteriorating, which occasionally one would. I can assure you that we were incredibly protective of our ideas and how they were carefully blended to form our stock selection model.

So, I was surprised to see an email today highlighting the forecasting ability of a particular “factor”. In this case, it was a Free Cash Flow factor. Now, we used FCF as one of our indicators 20+ years ago, so there isn’t anything particularly new. But, again, why highlight the supposed value added? Back in 2007, the quant space underwent a significant correction as many of the leading practitioners were engaged in very crowded trades as a result of having significant value biases among their various models. It wasn’t that these firms lost their edge, it was the result of too much money chasing to few good ideas.

Investment firms in our industry have a tendency to grow AUM far beyond the natural capacity of an insight or strategy. The result is the arbitraging away of one’s own insights rendering those factors more harmful than good. Again, if capacity is an issue, and it is, then why highlight one’s secret sauce? The capacity of a particular insight is going to be different depending on that factor. Each one will have a different alpha decay that is dependent the availability of the data, on the number and size of other investment firms using that insight or a similar idea, the trading frequency of the strategy, the AUM of the strategy, and where it is applied to various segments of our equity market, such as small cap exposure. These insights need to be monitored closely and changes shouldn’t be frowned on, as strategies that don’t evolve are ultimately going to be rendered to the status of expensive index funds, at best.

At Ryan ALM, Inc. we are not engaged in stock selection activities and our selection of bonds for our Cash Flow Matching (CFM) portfolios depend on many fundamental and quantitative credit research ideas. However, we do have a unique cost optimization process that we believe differentiates us from our competition. Our model has proven to be extremely cash flow efficient. What does that mean? It means that we don’t have a lot of excess cash from month to month which would reduce the cost savings of the implementation longer-term. All CFM implementations are not the same.

Getting behind the curtain of the various CFM strategies is not easy, but it should be a task worth pursuing. One way to accomplish the objective would be to ask multiple CFM managers to “build” a portfolio using the same projected benefits/expenses and contributions in order to see which firm produces the greatest reduction in cost, which can be impacted by factors such as the the type of securities used, credit quality, length of the assignment, etc. You can try to get us to disclose our secret sauce – good luck. We will, however, be happy to produce an initial review of a potential CFM portfolio so that you can evaluate the benefit(s) of adopting a Ryan ALM CFM program in order to compare us to the competition. We aren’t scared.