The Return of Stock-picking

It might feel like a thing of the past, but it's only a matter of time before stock-picking savvy will seriously matter again.

Right now, everything in the financial markets is correlating, says Alan Zafran, Partner at Luminous Capital. These days, it's not unheard of for 90 percent of all stocks on the S&P to move up or down the same direction on a single day. So stock-to-stock comparisons can feel redundant.

In 2012, however, Zafran predicts the markets will start balancing out, “returning to the mean.” Long/short equity financial managers and hedge funds with the skills to identify outperforming stocks will be the big winners.

“Once we return to an environment where stock picking matters, [hedge funds] with stock-picking skills and [quality] analysis will do well,” he says.

More generally, Zafran says he also expects an uptick in merger arbitrage as a consequence of low stock prices and companies suddenly flush with cash. For hedge funds with a certain set of skills, he also sees big opportunities in distressed credit funds.

To take advantage of privately negotiated distressed credit funds, he says investors need four specific things:

• Capital, because the man with the gold makes the rules.
• Relationships. Someone to make that phone call and avoid a bidding war.
• Skill to find the value in the funds, beyond the obvious.
• The internal structure to manage and service the fund. There needs to be people on the ground chasing down borrowers, he says. Many hedge funds don't have that ability.

Zafran has served as a financial adviser to wealthy families and institutional investors for the past 20 years. He began his career at Goldman Sachs and founded Luminous Capital with his partners in 2008. He will be moderating the opening panel at the Alpha Institute CIO Summit in New York City on October 26 and 27.