Alpha being airlifted out of dying portable alpha strategies
| Sep 23rd, 2009 | Filed under: Academic Research, Portable Alpha & Alpha/Beta Separation, Today's Post | By: Alpha Male |
|
It seems that after losing their shirts in equity beta, a surfeit of pension funds are now swearing off portable alpha strategies. Late last year, we discussed how the Pennsylvania State Employees Retirement System (SERS) had taken an equity bath during 2008. And Pensions & Investments reports this week on two other major public plans – in Massachusetts and Colorado – that have opted to call it day when it comes to portable alpha. Even the mythical California Public Employees Retirement System (CalPERS) has recently decided to wrap up its portable alpha program (Ed: Great reporting in these P&I pieces btw. Well worth a read.)
This website was launched just as the notion of alpha/beta separation was beginning to take hold. Over the past 3 years, we have advocated for the delineation of alpha and beta, both conceptually (in a portfolio and fee analysis context) and literally (as in portable alpha programs). By virtue of their focus on alpha-centric returns, alternative investment strategies such as hedge funds were a natural source for the alpha-centric portion of these strategies.
Unfortunately, the term “portable alpha” quickly became synonymous with hedge funds themselves. Generally, when someone asked whether a fund has adopted a portable alpha strategy, they really meant to ask if the fund had invested in hedge funds.
To continue reading this article please login (at the right) or click here to learn more about accessing our archives.
The beta component of a portable alpha strategy should have been recognized as leverage. The alpha component, usually a Fund of Hedge Funds, did better than the beta component but failed to adequately protect the downside, losing 15 to 20%. The idea of combining the strategies in portable alpha was a creation of misdirected “rocket scientists” whose mandate was to sell product. Any risk system or stress testing would have shown the compound loss potential due to the leverage.
I totally agree with the comment posted by Mr. Wartman.
The “misdirected rocket scientist” easily convinced the non-sophisticated corporate pension plan committee that is was a good idea, as a principle.
This “misdirected rocket scientist”, offering not only asset allocation services, has encroached on the manager selection business, assuming that they were also equipped with the tools to identify alpha-generation engines, and obviously proposing their services to that committee (why not, it’s good business).
They clearly failed at this, and the resulting portfolio effect can better be described as “portable leverage”, i.e. leveraged beta that severely hit the plan assets in 2008.
But guess what? These “misdirected rocket scientists” now have a new fee generating business for these now more-than-ever-desperate pension committees, its called “portfolio immunization”. Unfortunately, the committee has no choice but accept another invoice by these “misdirected rocket scientists” .
Here is the issue with portable alpha as I see it. If one mis-specifies the risk benchmark, then a beta (no matter how plain or exotic) becomes an alpha. In a liquidity meltdown, if betas then correlate, the investor is left with a leveraged beta bet. This bet’s conditional return distribution leaves the investor with a simple leveraged beta. This creates an outcome that is far worse than the beta one started out diversifying in the first place. Everything can be ported, just make sure what you are porting is really alpha.
There is nothing wrong with the proper harnessing of beta (tactically) to derive absolute returns. This can be accomplished through (1) the dynamic sizing of individual positions, and (2) the dynamic calibration of the net portfolio exposure. However, it must be undertaken within a disciplined trading framework. Absolute returns have very little (or absolutely nothing) to do with investing; it is obtained through disciplined trading. That is where it comes from, i.e. the proprietary trading desks.
Here is another recent reading on the issue: http://www.thehedgefundjournal.com/magazine/201001/research/misguided-rocket-scientists.php