While nearly all institutional investors are now clear about the benefits of portable alpha, many are still put off by its often complex mechanics. Unlike a simple active long-only mandate, a portable alpha strategy can often involve multiple accounts, the assumption of counterparty risk when using swaps for beta exposure, and cash management and rebalancing due to collateral requirements, not to mention new reporting and analytical requirements. These challenges – amplified by the headline risk of potentially dropping the ball somewhere along the line – have put the breaks on portable alpha programs at many institutions. This, even as these investors readily acknowledge the theoretical advantages of such a strategy.
So says Angelo Calvello of Man Investments in an “institutional investor only” white paper released earlier this year. Calvello is one of the instigators of the alpha-centric revolution, using the term “alpha-centric” as far back as 2005 (see related posting). Acknowledging the operational challenges inherent in a relatively complex strategy such as portable alpha, he now proposes a “bundled” solution that wraps the various components of portable alpha into one entity, such as a special purpose vehicle or a fund). According to Calvello, this would dramatically simplify the lives of pensions and endowments that are current reticent about diving into portable alpha.
Calvello has been around the portable alpha word for quite a while and talks to a lot of institutions about it every week. So his paper is worth a read. His thesis:
“The now-classic example of portable alpha is a return enhancement strategy where the desired beta exposure is acquired synthetically (via futures or swaps) and the alpha is provided by some type of market neutral hedge fund or fund of hedge funds. This is what I call the building block approach to portable alpha.”
“…my experience reveals that most of these challenges are more directly associated with the installation, implementation, and management of a portable alpha strategy. These complexities often confound and frustrate investors, ultimately discouraging an investment in portable alpha strategies despite the performance and investment benefits.”
“The primary difference is that a single manager provides both the alpha and beta in an integrated fashion within a legal structure that simplifies the installation and management of the strategy. The result, as we shall see, is a portable alpha strategy with fewer challenges and more benefits.”
To address this common source of portable alpha push-back, Calvello proposes a solution whereby all components are bundled into one offering. He says it could look something like this:
By wrapping the moving parts into one entity, the end investor realizes several advantages, according to Calvello. He summarizes these advantages in the following chart comparing “conventional” active long-only, traditional “unbundled” portable alpha, and his proposed “bundled” solution:
Calvello’s bundled solution essentially addresses a need first identified by Morgan Stanley’s Mark Baumgartner for portable alpha to “cross the chasm”, as they say in Silicon Valley, between the early adopters of a new technology and “the early majority” (see related posting). Technology author Geoffrey Moore argues that if products to cross this chasm, they must appeal to an audience that cares little about the technical intricacies and mechanics. The problem in the tech world is that successful suppliers of the early adopters get too hung up with these features and are then unable to satisfy the needs of the broader marketplace. If this model holds, then Calvello’s bundling idea may be just the thing for which the average institutional investor is looking.