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Concentration, Opacity, Illiquidity, Leverage, Skill (COILS)

TACTICS TO GENERATE ALPHA

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With all alpha tactics, the strategies should only be deployed if the investor can afford to lose the amount invested.

SUMMARY

Alpha is a risk-adjusted measure of excess return on an investment. Successfully producing alpha over long periods is difficult, but a measure very much sought after. One way to generate alpha is to exploit inefficiencies. This paper takes a closer look at five fundamental ways to uncover these opportunities: Concentration, Opacity, Illiquidity, Leverage, and Skill (COILS).

While there are opportunities to generate significant alpha, these strategies should be reserved for portions of a portfolio that can afford to pursue a longer-term view and more risk. Investors should think about investments in their portfolios fitting into three buckets: Liquidity Bucket, Lifestyle Bucket, and Aspirational Bucket. The investment types mentioned in this paper fall into the third bucket. When used with caution, these investment strategies can yield impressive results but must be entered into with complete knowledge about the significant risks involved.

KEY TAKEAWAYS

  • Concentration in a single company or a specific asset class can produce alpha, but with more risk than a completely diversified portfolio.
  • Opacity, or lack of public information, can result in mispricing in the market and investment opportunity, along with uncertainty about the unknown future behavior of the investment.
  • Illiquid assets offer investors the opportunity for higher returns; however, they may make sense for investors with other sources of liquid investments for short-term financial needs.
  • A leverage strategy requires an investor to borrow funds to finance assets that have higher yields than the cost to borrow.
  • A skill strategy depends on using extensive research to find investment managers with exceptional talent to uncover potentially profitable opportunities.

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