Overlays Wake Up From Long Slumber
Jun 12th, 2007 | Filed under: Portable Alpha & Alpha/Beta SeparationHere’s a piece of little-known trivia: When this website was being conceived, the leading candidate for a name was “ActiveOverlay.com”, not AllAboutAlpha.com. But the term “overlay” was generally used to describe active currency management, not active equity management. Besides, “ActiveOverlay.com” elicited a lot of blank looks among those not familiar with institutional portfolio management techniques. So we eventually settled on the more mainstream name in use today.
Since that time, active overlay has also come to refer to the process of tax management in unified managed accounts (see posting). But it never seemed to catch on as a term used to describe alpha-centric investing techniques such as 130/30 (which can be alternatively described as a beta portfolio with an active overlay). In fact, a Google search of “active overlay” returns precious few citations referring to equity overlay management (a.k.a. beta overlays or long/short overlays).
AllAboutAlpha contains only one posting (out of 300+) on the topic. In 2004, the Canada Pension Plan began using an active overlay strategy that amounted to synthetically shorting against their $80 billion passive portfolio. The CPP awarded four $500m “notional mandates” to manage in a market neutral (read: all alpha) strategy. But that was three years ago. Since then, no one seems to have seen much of the term “overlay”.
However, after several years asleep in the woods, ”Overlay-Van-Winkle” seems to have stumbled into town by way of this Hedgeworld piece (free registration required). It’s a little thinner, hasn’t showered in years and has a long “mountain man” beard. But most alarmingly, it seems to also have amnesia. And no one is sure exactly who it is, or what it’s supposed to do now…
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From my point of view, active overlay and portable alpha are one and the same class of stratgeies that incorporate one necessary ingredient; alpha/beta separation. In its typical form it involves a cash investment and a derivative. The overlay(notional)can be the beta portion or the alpha portion as can the cash portion, but not usually at the same time.
Not to quibble (because I hate to be a quibbler) but the quote attributed to me was actually supposed to be an example of overlay (as found in the last sentence in the quote: “a type of overlay”), not my or Northwater’s definition of overlay. I don’t think my view is in contrast to that of CPP or any other Canuck. In fact, my earlier quote in the Hedgeworld article was more in agreement with your point on the P&I numbers and the CPP use of overlay (”the uses of overlay are almost endless”).
Bob, Thanks for the clarification…not a quibble at all.