From an Interview with Chad Myhre, Portfolio Manager, Public School & Education Employee Retirement Systems of Missouri:

CIO: What’s the most challenging?

Myhre: One of the greatest challenges we all face is the increasing difficulty of alpha generation. As retail investors continue to move towards passive investing, the allocator community we are all a part of is slowly becoming the market. So, while technically not 100% true, alpha is, by and large, a zero-sum game. Therefore, we are essentially playing a game of poker where the weak hands are leaving the table and the asset managers we hire are collecting a healthy rake. For those of us who are going to continue to play this game, we need to be crystal clear as to why we have an advantage.

Unfortunately, that advantage usually involves a significant tolerance for pain. If you think about the Fundamental Law of Active Management, the value a manager delivers will be dependent upon her level of skill and the number of bets she makes. The implication is that we should allocate capital to highly diversified managers with short time horizons, so that even if that manager’s hit rate only marginally exceeds 50%, the law of large numbers will lead to a positive outcome. The challenge is that as developed markets have become much more analytically efficient, the small edge that highly diversified managers have historically held has largely evaporated, thus forcing concentration and/or sector expertise.

In addition, informational efficiencies have forced fundamental managers to increase their holding periods, leading to lower levels of turnover. As a result, allocating capital to fundamental-focused managers will continue to be accompanied by lengthy periods of underperformance that is little more than noise. Intestinal fortitude and communicating proper expectations to stakeholders are now pre-requisites for successful implementation.

source: Interview of Chad Myhre, Portfolio Manager, Public School & Education Employee Retirement Systems of Missouri, by Chief Investment Officer—CIO.