Alpha Shop
Oct 5th, 2006 | Filed under: Institutional Investing, Portable Alpha & Alpha/Beta SeparationBy: Max Darnell, First Quadrant
Published: April 2004
First Quadrant was a pioneer in Alpha/Beta bifurcation and were even advocating portable alpha back in the late 90’s (when, to its chagrin, beta was producing double digit returns and no one cared about alpha). So they’ve developed a very acute “sense of alpha” over the years. This article, written by the firm’s CIO, Max Darnell, summarizes their unique alpha-centric view on investing (even if it is a little self-congratulatory).
Darnell starts by highlighting a common misunderstanding about alpha - that it is simply out-perforance of a benchmark.
“What is this alpha really? Is it value added relative to a benchmark? If I build a high beta portfolio of stocks from the S&P 500 and beat the S&P 500 over the course of a bull market, have I delivered alpha? I’ve certainly beaten the benchmark.”
He points out the arguments made my many of the papers and articles at AllAboutAlpha: that alpha is often just “exotic beta”, that numerous systematic risk factors exist beside the market, and that any one of them can produce “market-beating” returns.
“Most would agree that the small cap bet is a bias, which somehow means that it isn’t alpha either. So what’s the difference between screening on market capitalization - or price/book for that matter - and screening on discretionary accruals? Nothing other than the fact that small cap stocks have been identified in the literature as a style that has had a long-term payoff and therefore has been officially recognized. We would say that there isn’t a difference between them. They both represent a systematic risk that can be easily produced by screening the stock universe for some objective characteristics of stocks.”
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[…] Alpha Shop […]
[…] Alpha Shop (Max Darnell, CIO, First Quadrant): for raising some interesting, somewhat philosophical, questions about whether skill-based managers who employ screening techniques actually produce a form of beta, not true alpha. […]
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