Separating Alpha from Beta
Sep 14th, 2006 | Filed under: Portable Alpha & Alpha/Beta SeparationBy: Nathan Dudley, Russell Investment Group
Published: Spring 2006, Canadian Investment Review
In this article about portable alpha, Nathan Dudley discusses portable alpha’s little-known and unsung younger brother portable beta.
“There are also variations. A more complex application involves physical assets with an alpha source that has inherent market exposure combined with a long/short synthetic position. The synthetic position is long on the desired beta exposure and short on the undesired beta exposure inherent in the alpha source. For example, physical assets could be given to an EAFE equity manager. The EAFE index could be sold short synthetically and another asset class such as large-cap U.S. equity could be bought long. The return pattern now becomes cash + alpha + beta(eafe) –beta(eafe) + beta(uslgcap). Clearly, managing the beta exposure in these cases is critical.”
“…beta management is more efficient when done at the total fund level rather than the individual account level. This allows for netting of trades, economies of scale, and increased flexibility.”
This suggests investors need a separate beta manager to delineate and aggregate beta sources throughout a portfolio, then dynamically short-out (or add to) these betas to fit within investment mandates. Some have called this “portable beta”, but perhaps a better term might be “dynamic beta”.
