Convergence at The Rockefeller Center

There comes a point in the evolution of many news ideas where the lines begin to blur between topics previously thought to be distinct.  This convergence of seemingly disparate disciplines is reminder that each topic has more in common that previously thought.  That moment of convergence came today at an event across the street from the storied Rockefeller Center and down the way a little from the Radio City Music Hall in New York.

Organizers of this conference on Portable Alpha & 130/30 clearly saw that these two strategies shared fundamental similarities.  But quite unexpectedly, the totally separate topic of alternative beta, also reared its head several times throughout the course of the day.

In retrospect, it makes a lot of sense.  Advocates of portable alpha have long argued that alpha can be isolated from a traditional long-only fund by simply shorting out market exposure.  And if a ready to port alpha source such as a fund of hedge funds is used, then its returns must already be uncorrelated with the beta source to which it will eventually be married.

But what if the remaining alpha is actually a combination of various alternative betas?  In fact, what if that alpha actually contained no true alpha at all, but was instead a stable set of risk factors that produce positive and enduring premiums?  Does that matter?  After all, alternative beta might just as well satisfy the non-correlation requirement that forms the foundation of a portable alpha strategy.

According to several panelists, it doesn’t really matter – as long as the fees reflect the nature of the non-market-beta returns.  In other words, alpha may be worth the mythical “2 and 20”, but alternative betas may be worth anywhere from a few basis points up to 2 and 20 depending on the availability of easy-to-trade proxies for these risk factors.   (Fama/French factors may be worth closer to a few bps while some screwy exotic beta or recently discovered systematic trade may be worth closer to 2 and 20.)

It’s quite conceivable than an investor might short-out the market exposure of a manager simply to isolate, not alpha, but some exotic beta that has not yet become part of the myriad of liquid ETFs and futures.  In a sense, this would amount to a custom security or a home-made (or at least home-distilled) beta.  If portable alpha might just as well be described as portable alternative beta, then the venerable strategy simply boils down to the efficient combination of traditional and exotic risk factors.

This sure isn’t news to some of the world’s more sophisticated funds of funds (e.g. DGAM, see related posting) who have been approaching portfolio construction as an exercise in alternative beta alchemy for quite some time.  But for typical portable alpha investors, this is an important realization – just because it’s uncorrelated to the market, doesn’t mean it’s pure alpha, or even that it’s alpha at all.

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