By: Milton Ezrati, Lord, Abbett & Co.
Published: Fall 2006, Journal of Investing

Milton Ezrati (see previous posting on his work) shows us in this article that alpha-centric investing is about much more than just hedge funds.  In fact, it appears that Ezrati would agree with AllAboutAlpha.com that hedge funds are just one symptom of a far bigger trend in money management.

Says Ezrati:

“Investors can employ portable alpha strategies without turning either to hedge funds or to leverage or any of these particular risks. In time, as this difference becomes apparent, the investment community will begin to embrace the advantages of portable alpha. The approach will gain greater currency, inside and outside hedge funds, and will begin to edge out more traditional approaches to investing, most especially the more conservative traditional investment managers.”

“Once the coming hedge fund shake out runs its course and investors return seriously to consider the fundamental contribution of portable alpha strategies, whether implemented in hedge funds or not, portable alpha should begin to offer a more lasting challenge to more traditional investment approaches.”

He suggests that advances in “techniques and systems” will enable this evolution…

“As techniques and systems develop to make it easier and more cost effective to monitor and administer portable alpha strategies, institutions should find it easier to experiment with the approach and subsequently use portable alpha systematically for a greater portion of their overall investment portfolio.”

AllAboutAlpha’s Alpha Male has also suggested that new financial “technologies” will enable the disintermediation of traditional investment value-propositions (see posting).

Ezrati argues that alpha/beta separation contributes to fee transparency (another common theme on this blog – click “fees and alpha” to the right).

“While providing this flexibility, portable alpha should also make fees easier to assess. Because traditional management conjoins the alpha and beta parts of the portfolio, fees cover both the index management and the performance parts. It is often difficult for the investor to disentangle exactly what part of the fee goes to what part of the management. But because portable alpha separates these two functions, the fee structure becomes completely transparent.”

He reiterates the operational concerns raised by several other commentators covered on AllAboutAlpha.com…

“…the portable alpha approach carries a number of significant administrative and technical difficulties. Take, for instance, the approach’s need to establish an indexed beta part of the strategy…the effort becomes significantly more difficult when seeking exposure to indices or disciplines that are harder to replicate.”

“[A portable alpha strategy] needs constant monitoring to ensure that the alpha part has no relation to the underlying indices and that any derivatives strategy carries the correct margin. These needs can require considerable quantitative and administrative support…”

Finally, Ezrati predicts that portable-alpha-like strategies will eventually be adopted – in some form - by retail investors.

“Portable alpha in time will make inroads into areas of individual investment where once traditional investment approaches held complete sway. The penetration will probably never get as far as in the institutional area, but in its own small way, the presence and growing effectiveness of this portable alpha alternative should, at the margin at least, limit the growth of traditional investment approaches, even among individual investors.”

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