U.S. Financial Markets and the Last Alpha Frontier

Randy Mitterling is a Principal and Chief Compliance Officer of Applied Capital, LLC, a FINRA Member Broker Dealer. Applied Capital, LLC is a wholly owned affiliate of FNEX, LLC.

Somewhere between parenting teenagers and herding farm animals lies the regulatory oversight of U.S. financial markets.

Teenagers get clearly defined rules and consequences for bad behavior, while livestock get electric prods and barbed wire.

Perhaps we’re receiving some of the latter, too, because our elected officials are prodding and coaxing our financial markets like sheep into a pen of mediocrity.

Much of the increased financial regulation of the past five years was created to protect you from yourself. It’s ironic that the same people making up these rules are from the generation that grew up with lawn darts and wood burnrning kits. Taking risks and failing used to be an integral part of growing up. Our parents would say that pain was a great teacher and our rite of passage was made up of skinned knees and bumps on our heads.

What has happened to us, America?

Politicians and regulators don’t want you to be exposed to alpha. The alpha factor is what your investment manager provides. By selecting securities or making the choice to buy or sell, a portfolio will outperform (positive alpha) or underperform (negative alpha) against the broader markets.

We allow them to tell us that it’s too risky. Pursuing alpha is risky. It used to be that if you took some risk and failed, it would be a teachable moment. You asked: “What did I do wrong? How I can avoid making that same mistake again?”

Now, the goal appears to be system-wide, homogenized beta with very little chance of alpha. When did risk become a bad thing?

In this new era of systemic transparency and full disclosure of strategies, is it even possible to outperform the broad market indexes over the long term, regardless of risk? Let’s take a look at how risk can be a positive step in searching for alpha.

Epsilon Theory author Ben Hunt, Ph.D., explains it brilliantly in his March 16 Note titled – ‘Panopticon’:

“Capturing alpha in an investment strategy requires private information. To the degree that forced regulatory transparency and Big Data technology reduce private information by turnrning it into common knowledge, there is less alpha in markets. That’s a cold, hard fact. Finding alpha has never been easy. It’s always been the rarest thing in the investing world, but now it’s truly an endangered species, particularly in the stock-picking world of fundamental analysis of public companies.

“We have moved from a regulatory environment where illegal private information was pretty much defined as stealing the orange growers’ crop report from the USDA a la Trading Places (Mortimer Duke: ‘Turnrn those machines back on!’), to an environment where the mere existence of market-beating investment returnrns is treated as prima facie evidence that you must have been doing something illegal to generate those returnrns.”

Take a look at any study of mutual fund performance over a 10-year period or longer and you’ll find that less than half of 1% actually outperformed the S&P 500 Index. Before you say it, I know those are passive investments and your expectations probably aren’t too high to begin with, but what about actively managed portfolios? Let’s see how they are doing.

The 2014 DALBAR Quantitative Analysis of Investor Behavior (QAIB) report showed a 20-year returnrn of 9.22% for the S&P 500 compared to real investor returnrns of 5.02%.

I don’t need to pull out my Rule of 72 Calculator to know how bad that is. How can people who have been hearing “buy low, sell high” for their entire lives keep making the same mistakes year after year? The answer is emotions, of course. The market highs reflect our exuberance and the lows reflect our fear.

Talk about irrational economics (pun intended)!

We can and should do better, but how? We can’t find alpha because we have nowhere to go with index funds kicking our collective butts every year. What can we add to our portfolios to smooth out the volatility and force us to take some of the emotion out of our decisions?

Let’s go back to Dr. Ben Hunt’s quote and put the key words in bold capital letters. He wrote, “Capturing ALPHA in an investment strategy requires PRIVATE information.”

Hold on… before you think I’m an advocate for insider trading, let me stop you right there. I’m talking about the world of private investments offered by entrepreneurs and growth-stage companies. With these opportunities, private means limited supply and a smaller circle of investors that share knowledge of the company financials and operations; all without the regulatory weight of fully disclosing their strategies publicly for all to see (and copy). (It’s important to understand that private doesn’t mean unregulated).

The biggest challenge in private placement investments has always been finding opportunities. Your personal banker or broker dealer may offer a private fund, real estate investment, or a local venture capital deal but after you get your fill of those offerings, the pickings get pretty slim. You have to know how to track and where to hunt.

That’s why I’m going to be at the Irrational Economic Summit this October. I’ll show you a centralized source of private placement offerings from companies around the U.S. You’ll wonder how you’ve gotten along without it for so long. Come by and visit me at the FNEX exhibition stand.

Randy Mitterling

Randy Mitterling, Chief Compliance Officer 


Mr. Mitterling co-founded i4 Advisors, LLC, an Indiana Registered Investment Advisor. Mr. Mitterling serves as the Chief Investment Advisor and Chief Compliance Officer of i4. As the Chief Investment Advisor, Mr. Mitterling is responsible for researching, recommending, and trading the firm’s discretionary accounts. As the CCO, Mr. Mitterling develops and maintains i4’s internrnal operating procedures, ensures that i4 comply with all regulations, and maintains the books and records of the firm. From 2009 to 2011, Mr. Mitterling worked as an Investment Advisor Representative with One America Securities and Lincoln Financial Securities where he was responsible for selling life insurance and annuity products and offered individual investment advice and portfolio management. Prior to founding i4 Advisors, Mr. Mitterling spent seven years in sales for a national chemical manufacturer achieving President’s Club levels of annual sales revenue. Mr. Mitterling started his career in the insurance and banking industries before joining Robert Half Internrnational, a Fortune 500 staffing company, where he worked as a Recruiter and Division Director. Mr. Mitterling obtained his Bachelor of Science degree in Finance from Ball State University. He holds the Series 3, 7, 24, 66, and 79 securities industry qualifying examinations.

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Todd R. Ryden, CEO & Founder

Todd  RydenMr. Ryden is an experienced entrepreneur and manager, having founded and sold several enterprises. After practicing law, Mr. Ryden co-founded StarCom Broadband, a cable and high-speed data provider. StarCom was sold in 2001 to Comcast®. Mr. Ryden co-founded Cole Marketing, a bottled water brand-marketing group, acquired in 2006 by a New York based venture capital group. Mr. Ryden co-founded Caldera Development, a real estate development company that has participated in the development of over 430,000sf of retail and office space. Mr. Ryden was a co-founder of ViaStar Energy, Inc. which provided utility management services nationwide. ViaStar’s Automated Meter Reading technology was acquired by Motorola® in 2007 and its utility services division was acquired in 2008 by NWP Services Corp. ®. Mr. Ryden is the Managing Director of The Applied Group, a private equity firm. Prior to entering the business world, Mr. Ryden’s legal career included litigating at the Indiana Supreme Court, and representing the State of Indiana in the tobacco litigation. Mr. Ryden obtained his Juris Doctorate from Indiana University School of Law in Indianapolis, has a certificate in Internrnational Contract Law from Tulane University, Paris, France, and obtained his B.A. from Purdue University. He has been a member of the American and Indiana Bar Associations, serves as President of the Board of Directors of Big Brothers and Big Sisters of Central Indiana, is a Board Member of Christel House’s Drop Out Recovery School and has been a guest lecturer at Purdue University, Ball State University and the University of Indianapolis.