Global Pension Crisis: Unfunded Liabilities and How We Can Fill the Gap

CHAPTER 7

The Long and the Short of It . . . Trust Me

One of the most interesting, profitable, and yet pernicious aspects of the securities markets and money management revolves around shorting and the borrowing of securities to perform this function. As pension funds ease into the deep end of the asset management pool, they begin to encounter these issues and the rewards and risks are enormous, as I try to explain in this chapter.

This chapter focuses on the elements of the asset management industry that most critically add to success, but that are outside the traditional realm of investment strategy. It is generally understood today that risk is comprised of many elements and includes a significant component of operational risk. In the same way, return is often described as being comprised of systemic and specific elements or beta and alpha. Much confusion exists around the delineation of alpha and beta, and alpha is sometimes thought to be better characterized as exotic beta or beta is characterized as synthetic alpha. There are, however, operational elements of the investment process that clearly add or detract significant value from returns just like operational risk can add to or detract from overall risk.

These operational elements that add to returns are called many things, but the one thing you need to be very careful not to call them is “operational alpha.” When I started teaching my course about how alpha can come from how a manager operates the back office, I logically ...