Alpha Beta Separation, Transportation and Recombination

By: Bruce Brittain, Sabrina Callin, James Keller, John Loftus, James Moore, PIMCO
Published: May 2005

Excerpts:

In the search for new ways to maximize investment returns, the concept of separating manager skill from market risk and return, or alpha from beta, and recombining them in innovative ways has sparked significant interest, and debate, among institutional investors.

But what do we mean by “alpha” and “beta”? Alpha refers to the excess return, adjusted for risk, that an active manager seeks to add relative to a given market index. Beta represents the risk and return produced by the market index or asset class. “Portable alpha” refers to separating the active manager’s excess return from the base market return and transporting the alpha to some other market index.

As an active fixed income manager, the concept of portable alpha has been central to the PIMCO investment process for nearly 20 years. Our experience has taught us that separating alpha from beta is a little like splitting the atom. While the results can be powerful, portable alpha strategies can have negative side effects if not managed in a controlled fashion by experienced professionals.

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