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This episode aired on BloombergTV on Sep 18, 2012

Horizon Arbitrage

Horizon Arbitrage is an investing strategy that distinguishes itself by focusing on the long term. Such strategies see little gain to be made in short-term opportunities, and instead identify investments with longer time horizons.

Q. Well, now, this is a bit of a mysterious term.

A. Yes, but pretty simple, really. “Horizon” refers to time horizon. A lot of major institutions are coming around to the idea that there’s simply too much focus on the short term in investing, and there’s no alpha there. They think longer term values are being ignored. So strategies that aim at that disparity are being called “horizon arbitrage” plays.

Q. I’m sure you have some examples.

A. The term is probably used the most to describe activist investors, who take a position in a stock and expect to work for a long time before they get the result they are looking for. As you know, these folks usually take a position in a company, file a 13D, and then approach management with some ideas about how to get the stock price up. Sometimes its pretty friendly– some funds specialize in that– and sometimes its open and pretty hostile — other funds are more known for that.

Q. And obviously that’s the sort of strategy that requires patience, a long time horizon.

A. To show you how long they expect that to take, each investment is called a “campaign”. Even if it’s a friendly deal, they call it a “constructive campaign”… its going to take a while to, for example, spin off a division and have the market recognize the new value.

Q. And how have those strategies been working out for investors?

A. Pretty darn well, actually. Since the crash, the top tier activist funds have been averaging somewhere around 9%, way better than the overall markets, and have even shown less volatility to boot.

Q. So that does look like alpha generation.

A. It does, which illustrates a larger point. I think people are pretty much coming around to a pretty common sense idea: usually, “alpha” generation comes down to a lot of hard work in some form or fashion. The hope that you’ll find someone who has a better trading strategy that works over long periods, or beat the market by using generally available information, is losing steam.

So, one thing I like to say is this: alpha takes work, and work takes time. And that’s the basis of “horizon arbitrage”.