Q. We all know that some managers are better than others, but the topic of manager performance dispersion is particularly hot topic in the alternatives world. Why?
A. Today, it’s because the Yale endowment just released its annual performance report and, low and behold, their outstanding peformance is not really due to allocation, but rather the superior returns generated by their active managers. They’re benefiting from performance dispersion– the difference between how the worst managers and the best managers perform in a given strategy.

Q. So, that’s interesting, because so many people argue that investing success is really about asset allocation more than it is specific managers. So is Yale proving that wrong?
A. Here’s a very interesting point. The difference between the best and worst long-only managers is not super huge– maybe 2X. If the worst guy makes 3%, the best makes 6%. But in many alternative categories, it’s far, far larger: as much as 10X or more in the same strategy. So simply ignoring manager performance dispersion is kinda crazy.

Q. Another reason, I guess, that you hate the “average hedge fund” statistics so much…
A. Exactly! Those are terribly misleading. You don’t invest in an average manager anymore than you take an average date to the prom…

Q. But what else does Yale’s great performance rely on?
A. Well, look, they’re really good at lots of things. But I would like to point out one of their own takeaways from the report, which is that they like to invest in managers with skin in the game. This is one of the basic reasons that alternatives can outperform traditional investments, even in the long-only space: when you have real alignment of interests, because the manager gets paid better if he wins, and suffers if he loses, your chances of extracting the best out of him really increases.

Q. And that’s true across all types of investments?
A. Well, some kinds of investments, like rolling Treasuries, probably not. But for the vast bulk of them, I’d say yes.