Investing Success Without Stock Picking
| Sep 4th, 2006 | Filed under: Portable Alpha & Alpha/Beta Separation | By: Alpha Male |
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By: John Kimelman, Barron’s
Published: August 15, 2006
In this interview, Michael Oyster, author of Mission Possible: Achieving Outperformance in a Low-Return World (Dearborn Trade Publishing, 2005) argues that portable alpha (and related strategies) will be the best way to beat the benchmark in the difficult years ahead.
Excerpts:
“…Oyster argues that the potential for outperformance lies in a host of alternative investment styles including enhanced index funds, covered-call writing, and a futures-based investment style called “portable alpha,” practiced mostly by institutions.”
“Q: I know you’re also a big fan of “portable alpha,” which is popular among institutions but hasn’t really caught on with individuals in spite of a few mutual funds that employ this approach. Can you explain how it works?”
“A: Let’s say you have $300,000 to invest. If you took just $30,000 of it and bought S&P 500 futures contracts, you can get about the same market exposure as investing all $300,000 in a stock-market index fund. So you only have to tie up 10% of your capital to get 100% of the return of the broader stock market. That’s the beta. Then I take the remaining $270,000 and I invest it in an alpha [or marketing-beating] strategy. I can put the money in short-term fixed income, and I simply attempt to beat the Libor rate [London interbank offered rate]. As long as my short-term fixed-income pool does better than Libor, then I’ve created alpha that I can put back to my original investment, and taken as a whole I now have the return of the S&P 500, plus some alpha. Now that’s a much more efficient way of investing than trying to pick stocks to outperform the S&P 500, because I have a stronger belief that my short-term bond portfolio will outperform Libor than I believe that a manager can pick stocks to outperform the S&P 500.
“Q: Is there a portable alpha mutual fund out there now?
“A: The Pimco Stocks Plus Total Return Fund (ticker: PSTDX) is one good example. I recognize that the performance of the fund lately has been poor because rising interest rates have made it difficult for the alpha-generating bond investing to outperform Libor. But over the long run, they have been able to produce alpha.
“Q: Critics of portable alpha say that it can be expensive and even risky, and, as you point out, the alpha isn’t always achieved. What’s your reaction?
“A: I’d say it’s difficult to place such broad generalities on portable alpha. It doesn’t have to be expensive or risky. Pimco Stocks Plus is a good example of a low-cost, low-risk way to play it. The deviation relative to its benchmark is going to be smaller than the average stockpicker.”
