Separating Alpha from Beta: Portable Alpha
| Jul 3rd, 2006 | Filed under: Portable Alpha & Alpha/Beta Separation | By: Alpha Male |
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Published By: IndexInvestor.com
This is a useful introduction to alpha, beta and portable alpha…
Excerpts:
“…we concluded that most investors would be better off using index products to implement their portfolio’s asset allocation strategy. However, a new development in the investing world – separation of alpha and beta – further complicates the choice between active and passive investing.”
“Now let’s move on to the more important part of the story: what makes this approach potentially attractive? The key here is the fact that pure alpha is theoretically uncorrelated with beta. And that makes it a potentially very valuable addition to an investor’s portfolio. Moreover, the separation of beta and alpha make it much easier for an investor to define and control his or her exposure to risk. For example, assume that your target asset allocation leads to a portfolio with an expected annual standard deviation of returns (volatility) of 15%, based on beta risk alone. You could then say, “I’m willing to take on a further 1% in risk in pursuit of additional alpha returns”. This type of calculation is close to impossible to make in a world of long-only actively managed funds that combine alpha and beta exposure. It is only when beta and alpha investing are separated that it becomes theoretically possible.”
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