As a student of the markets, knowing where to try and find alpha is an interesting problem. Basically, you have a few schools of economic thought out there. If we generalize extensively when it comes to markets we can form two groups; the behaviorists and the efficient markets.
Behaviorism in markets is newer. It’s sexy. It is appealing because it makes individuals think they have more power than they actually do. It appeals to our inner instincts that people are irrational and so when they make decisions, things get out of line.
In some cases, I think there is certainly a lot of behavioral economics at work. You can spot it in markets that are illiquid. For example, last week a scooter company went from a $1B valuation to a $2B valuation. Clearly, that is behaviorism and irrationality at work.
On the flip side, there are highly liquid markets. They hew to the theories on efficient markets. There is no way to beat them on a macro scale unless you are able to get some asymmetric information. You can beat them if you have an artificial edge, like speed. Speed can also help you get some asymmetric information. Maybe you see the order book faster, or the report of fills faster. That’s price information that the rest of the market doesn’t have and you can take advantage of it. Hence, you see firms spending millions to get speedier.
In a recent blogpost Drew Dickson said,
Technological advances have enhanced the speed of the dissemination of firm-specific information, and broadened its distribution. In this new, post-internet paradigm, after also considering the maturity (and size) of the investment management industry, we propose there is very little difference between large and small-capitalization equities in terms of relevant information available to the marginal investor. Consequently, we suggest that the notion that the equity prices of smaller capitalisation companies are somehow less efficiently priced than their larger brethren may potentially be stale.
Less alpha in small cap stocks is new. Drew’s conclusion that there might be alpha in large stocks is also new and counterintuitive. He also doesn’t cite speed as an advantage which is interesting given all the investment in speed. He makes a good case for his thesis but I want to think about money flowing in a different direction.
An aside, I love counterintuitive arguments. They aren’t linear and they cause you to stop and think. It’s why things like Coase Theorem and George Stigler’s research were so spot on and thought provoking.
Some money seeking alpha will move to new illiquid asset classes. Cryptocurrency might be one of those asset classes since when you want to get out, you can generally shop for a bid/offer somewhere.
Venture capital is certainly inefficient and often operates on the principles of behavioral economics but capital seeking alpha won’t go to venture in a large wave. It will trickle in because the holding period is too long and the liquidity too tight.
However, if the venture world gets tokenized, look out. The market should become more efficient and rational. Because we are in a tech renaissance, it might attract a lot of new capital that wouldn’t necessarily seek it out.
