Cost Focus as Barbell Portfolios Spread

Chidem Kurdas

The idea of combining index investments with skilled active managers is not new, having taken years to catch on. It may become the dominant asset allocation philosophy.

The reason is, investors say, beta is cheap while alpha is hard to find. That seems to be the impetus behind the barbell approach. Get your beta, that is, exposure to whatever markets you want, with low-fee index funds and exchange-traded funds. Then balance your exposure with investments that produce alpha, such as hedge funds and private equity.

Investors will continue to increase their use of passively managed products and ETFs, says Neal Epstein, a vice president at Moody’s Investors Service. At the same time, he finds there is demand for alternative managers as a less-volatile sources of return, despite the under-performance of hedge funds in 2011.

But investors want managers who beat markets—after all, they’re getting market returns from indexes. “Out-performance for active managers is even more decisive than in the past,” Mr. Epstein said, at a web conference.

Managers, for their part, argue that no strategy can beat markets all the time. How about taking the long-term view? Investors’ time horizon depends on what kind of investor they are, but even slow-moving institutions react to disappointing performance within a couple of years. Recently the giant California public pension, CalPERS, said that it its hedge fund investments underperformed the benchmark and are being reviewed.

Mr. Epstein says active managers struggle to deliver returns that exceed their excess cost. He talks about cost management. Manager compensation may be going down.

If you’re charging high fees, you’d better deliver high returns. The barbell delivers a clear message: show you’re better than the index.

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One Response to “Cost Focus as Barbell Portfolios Spread”

  1. Other Side of Yale Model: ETFs | HedgeFundSmarts Says:

    […] refer to this as the “barbell” asset allocation paradigm; cheap & easy ETFs on one end, expensive and illiquid alternative strategies on the other. One […]

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