Can Alpha Capture Save Fundamental Long/Short Equity Investing? | David Stemerman CenterBook Partners
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
In this revealing episode, David Stemerman, CEO, CIO, and Co-founder of CenterBook Partners, challenges the widespread narrative about the death of long-short equity investing. Despite declining new fund launches and shrinking assets under management, Stemerman argues that fundamental long-short equity managers still possess significant investing skill – it's just being masked by market forces and factor exposures. He presents a compelling case for "responsible alpha capture" as the solution to revitalize single manager hedge funds while meeting modern allocator demands. Through systematic portfolio construction, risk management, and strategic partnerships, CenterBook aims to unlock the pure alpha generated by skilled stock pickers and deliver it in formats that institutional investors actually want. (02:25)
- Core theme: How alpha capture can bridge the gap between skilled stock pickers and allocator demands for uncorrelated, factor-neutral returns
Speakers
David Stemerman
David Stemerman is CEO, CIO, and Co-founder of CenterBook Partners, a multibillion-dollar equity multi-strategy long-short hedge fund. He previously served as a partner at the notable Tiger Cub Lone Pine Capital under Steve Mandel, where he famously pitched Apple as a long position when others saw it as a potential short. After Lone Pine, he founded and ran Canatus Capital, which in 2008 was the largest single manager long-short equity fund with over $2 billion in assets under management.
Key Takeaways
Alpha Exists But Is Hidden by Market Noise
Despite the prevailing narrative that long-short equity is dead, Stemerman's research reveals that skilled bottom-up stock pickers still generate substantial alpha. (04:59) The problem isn't lack of skill – it's that pure stock-picking returns get masked by beta exposure and factor tilts that create volatility around the core alpha signal. Through daily analysis using risk models, CenterBook can isolate the idiosyncratic returns that represent true manager skill, often finding "wonderful return streams" that allocators are inadvertently ignoring in their flight from directional strategies.
Timing Separates Good Stock Pickers from Great Portfolio Managers
One of CenterBook's key insights is that exceptional stock pickers aren't necessarily great at timing their trades. (13:32) Stemerman notes that while their partner managers excel at identifying which stocks will outperform over 12-24 month periods, they often struggle with optimal entry and exit timing. This creates opportunity for systematic approaches to capture the same alpha through better execution timing, often trading at different times – and sometimes in opposite directions – from the underlying managers while still benefiting from their research insights.
The Centaur Model Combines Human Insight with Machine Optimization
Drawing from chess, where human grandmasters paired with computers (centaurs) beat either alone, CenterBook applies this concept to investing. (25:35) Humans excel at variant perception and identifying future winners, while machines optimize position sizing across 30 longs and 50 shorts while managing risk and factor exposure. This partnership allows managers to focus on their core competency – stock selection – while systematic approaches handle portfolio construction, a task "not well suited for the human brain." The result is returns neither could generate independently.
Responsible Alpha Capture Requires Transparency and Accountability
Unlike traditional alpha capture that may harm underlying manager performance, responsible alpha capture demands strict protocols. (10:11) CenterBook measures market impact, provides transparency to managers about their trading, and critically, reimburses funds for any negative impact caused by their trading activity. This approach is possible because fundamental managers have "long duration alpha" – their insights remain valuable for days or weeks, unlike sell-side recommendations that decay quickly. This allows for patient execution that doesn't interfere with manager trading.
Active Extension Represents the Future of Skilled Stock Picking
The ultimate evolution of this model is single-manager active extension strategies – essentially 130/30 funds done properly with systematic risk management. (53:15) While traditional 130/30 strategies largely died after 2008 due to leverage issues during market stress, Stemerman argues they can work with proper systematic risk management. These strategies could address the massive $28 trillion in traditional long-only assets that generate zero excess returns, while the much smaller $600 billion in hedge fund long-only strategies generate 2-3% outperformance.
Statistics & Facts
- Goldman Sachs data shows that traditional long-only managers collectively manage $28 trillion with zero excess returns, while hedge fund long-only strategies manage under $600 billion but generate 2-300 basis points of outperformance. (52:37)
- CenterBook's model portfolio recommendations using Alpha Theory software historically generate 400 basis points higher returns on average compared to managers' actual portfolios. (31:19)
- CenterBook currently works with over 35 managers and expects to grow to 40-50 in the near term, with over 100 managers as a long-term target. Their combined portfolio spans over 1,000 stocks across 25 countries. (46:47)
