AlphaTheory is like Moneyball for Money Managers

“You need algorithms, simple rule sets,” thought Cameron Hight, co-founder of Charlotte-based software firm AlphaTheory after reading Moneyball. The 2004 book by Michael Lewis would become a critical element in Mr. Hight’s inspiration for leaving a successful career at a hedge fund and founding a software company.  

In the book, Lewis profiles Billy Beane, General Manager of the Major League Baseball’s Oakland Athletics. Beane revolutionized baseball, and sports in general, by using carefully interpreted analytics to draft players and make roster decisions. Hight saw parallels between the fundamental data analysis techniques Beane was using drafting players and building a team and what he and other investment professionals were trying to accomplish in crafting winning investment strategies for their clients – by picking stocks and building portfolios. Like most humans, baseball managers are bad at absorbing lots of information and translating that information into sound decisions. Portfolio and fund managers are no different.

After graduating from UNC-Chapel Hill and becoming one of the youngest ever to earn the coveted Chartered Financial Analyst (CFA) designation, Hight started his career in New York as a sales side equity research analyst covering technology companies in the heat of the late 1990s and early 2000s dot-com boom. “I learned a lot of lessons about how people become emotional quickly, how that can lead to mistakes and therefore, mispriced assets.” Particularly, Hight observed that while fund managers were good at picking individual stocks, mistakes were made in how they would size positions and subsequently, adjust those positions when financial environments changed.

Traditionally, a portfolio manager absorbs information by fundamental stock analysis techniques such as interviewing the company’s management team and running projection models adjusting for various economic factors and business cycles. That information is then translated into a position size (the volume of a particular stock the manager buys or sells). The problem is they can’t entirely strip away their own behavioral factors. When that position size is more of a mental exercise, there is significant room for error.

The algorithms Hight developed behind the Alpha Theory software take those fundamental stock analysis techniques, along with various other portfolio factors, and allow managers to describe how they want to size positions. AlphaTheory will then come up with a suggested size.

In a portfolio of stocks, prices and information relating to individual companies constantly fluctuate due to changes – either within the company or due to a macroeconomic event. Prudent portfolio theory suggests that, when financial environments change, position sizes should also change. If not, gaps grow between where the portfolio is currently sized and where it should be sized. Over time, these gaps cause lost return and increased risk.

AlphaTheory will compare the position size that the fund manager chose with the size it suggested. As it compares those two sizes over time, AlphaTheory reveals where the discrepancies are in the position size. By reducing these discrepancies over time, the fund manager can develop a portfolio that will be a much closer reflection of the size he or she initially described versus what a human can actually accomplish.

“The goal is to create a portfolio that maximizes overall return given a set of constraints. Some of those constraints will be based on the fund manager’s own criterion (think diversification). We aren’t necessarily telling clients the best way to build a portfolio, just how to do it in a repeatable, thoughtful way.”

Hight originally built the model behind AlphaTheory in Excel then lent it out to colleagues and friends at other hedge funds to gauge usability and interest. By 2006, as interest piqued, Hight got in touch with two fraternity brothers who were software developers living in Boulder and London at the time. Soon thereafter, with the software mapped, the three co-founders went live with AlphaTheory in 2007.

Today, the company has 30 employees with most of the administrative and development functions in Charlotte. As the majority of Alpha’s customers are hedge funds and large asset managers, the sales and customer success teams operate out of New York City. Hight takes pride in the fact Alpha has been able to maintain its Charlotte base and still be on the cutting edge of financial technology and software development. His advice to entrepreneurs is simple yet powerful: “Be willing to make mistakes. Think of everything that you’re doing as an experiment. Be willing to adapt and not be too dogged about your beliefs. You have to be able to fail quickly then adapt.”

It really is all about adaptability, isn’t it? Whether it’s managing a portfolio or running a business, everything changes and it’s how we adapt to those changes that determine our success. AlphaTheory has clearly heeded its own mantra and moved from a start-up to a mature company proud to call Charlotte home.