By: Hugo Greenhalgh, FT Mandate
Published: November 2006

FT published a good overview of portable alpha in November.  It’s a follow-up to FT Mandate’s June 2006 piece called “Portable alpha gains widespread acceptance“.

A Disruptive Financial Technology

Greenhalgh suggests the development of new financial technologies is enabling portable alpha:

“With financial instruments such as swaps becoming more widely accepted, the notion of portable alpha has moved from the theoretical to a question of just how it can be applied.”

“…notes Morgan Stanley’s Brandon Horwitz. ‘But now it is slowly making its way into the mainstream. The key driver of this is that the derivatives to practically implement portable alpha are becoming much more liquid and much easier to use, and people are becoming more comfortable using them.’”

Early Majority Still Skeptical

While he acknowledges accounting and regulatory benefits to be derived from a portable alpha strategy, he also quotes industry players with a decidedly sober view of the industry.  Brandon Horwitz from Morgan Stanley tells Greenhalgh:

“Portable alpha is gaining acceptance and service providers are coming out with more products.  But it is not quite mainstream yet.”

What’s it Going to Take? Flat Equity Markets

Other industry suppliers quoted in his article say investors are more likely to adopt such strategies when equity returns stink.

“‘The US stock market lately has been disappointing so there has been an urgency to evolve out of that playbook,’ says Mr (Jeffrey) Knight (CIO at Putman Investments). ‘Investing a lot of money in stocks and waiting for the market to go up just wasn’t working.’”

What’s it Going to Take? Liability-Matching

The article says European institutions that match liabilities with duration-matched bonds are disappointed by the returns of these bonds.  Matching liabilities with alpha sources, it is argued, can provide both liability-matching and higher return potential.

“LDI allows you to synthetically gain the interest rate and inflation exposure you need to match your liabilities without committing capital,’ continues Mr Horwitz. ‘That is the key strength of an LDI strategy that uses swaps. If you enter into an LDI strategy you can use swaps to get that exposure and put your capital into an investment that gives you a better risk-return trade off.”

Bottom Line: a “Sea Change” in Investing

Greenhalgh observes what we at AllAboutAlpha.com have observed extensively, that portable alpha per se may be just the tip of the iceberg:

“Yet for many institutions discussion of portable alpha and derivative-based investment strategies has represented a sea change in how they conduct their investment business. I have seen plenty of continental pension funds hire risk managers in the last couple of years, notes Peter Preisler, head of business development at T. Rowe Price.

“The growing acceptance of the use of derivatives in financial planning has made talk of overlays and excess alpha commonplace, particularly within the context of the current liability-driven investment environment in continental Europe.”

The major theme running through this piece: portable alpha is tough because it’s hard to find alpha.  We don’t disagree.  But the same argument can (and should) be made about traditional long-only active management: any active investing is tough because it’s hard to find alpha.

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