New paper explains “muted demand” for portable alpha

As outside observers of the academic literature surrounding alpha-centric investing, we always find it curious that the easiest-to-read, most accessible papers and presentations are usually written by some of the field’s most accomplished and technically sophisticated members.  William Sharpe, Eugene Fama, Andrew Lo, Jacobs & Levy…each seems to be able to cast aside the trappings of academia and present cogent arguments in laymen’s terms.

By this standard, Larry Gorman is a name to watch.  The Cal Poly professor has a unique ability to come down from the ivory tower to help the rest of us get our head around the pressing academic issues of the day –  the Fundamental Law of Active Management, 1X0/X0, and the true meaning of alpha, for example.  But don’t take our word for it, Gorman has been named “Most Outstanding Faculty” in the Cal Poly finance department each of the past fours years.

Gorman recently teamed up with professor Robert Weigand of Washburn University to write this relatively easy to digest paper covering some of the roadblocks on the path to alpha-centric investing (called “Measuring Alpha Based Performance. Implications for Alpha Focused, Structured Products”).  Warn the duo:

“…with many products being marketed around the objective of “earning alpha” (e.g., Portable Alpha), it is critical to understand exactly what alpha is and is not. Perpetuating the confusion associated with alpha is likely to have an adverse effect on demand for structured investment products with an alpha focus.”

The paper goes on to make a series of observations regarding the misuse of CAPM, money management fees, performance metrics, and appropriate benchmarks.


The paper says the confusion regarding “alpha” begins with the CAPM itself.  According to Gorman and Weigand, ignoring Fama-French factors (small cap v large cap and value v growth) leads to false sightings of alpha.  Ergo, overcoming this “alpha-bias” will pave the way for greater adoption of alpha-centric strategies:

“If investors are educated to understand that Fama-French factors properly measure alpha, and that the information ratio (when measured from the investor’s perspective) provides a method for direct comparison of absolute and relative return products, then the current state of confusion surrounding alpha and interpretation of investment performance metrics will likely attenuate, leading to an improved understanding and acceptance of alpha-focused products. The result will likely be a significant increase in collective demand for all professionally managed alpha-focused products.”


While providing easy to produce beta returns under the banner of “alpha” may sound like a lucrative strategy for the asset management industry, the authors suggest this may be short-sighted.

“…paying a relatively large fee for access to alpha-based returns makes sense.  With a two-tier pricing structure between alpha and beta returns, a contaminated alpha is likely to be mispriced compared to what an investor can obtain their own.  This potential mispricing is not in the best interest of the money management industry, as it is likely to reduce investor demand for any product purporting to supply alpha…”

Performance Metrics

In an email to, Gorman also argued that “the lack of a common performance metric between (popular) 130/30 products, and (relatively unpopular) Portable Alpha products has contributed to Portable Alpha’s slow rate or acceptance.”

This point is also emphasized in the white paper where Gorman and Weigand argue that the information ratio is often ignored by those analyzing absolute return funds.  By comparing information ratios of long-only, 130/30 and portable alpha strategies, investors get an apples-to-apples comparison.

Appropriate Benchmarks

The paper also makes a point that we once described as “alpha is the eyes of the beholder”.  That is, should manager alpha be calculated as returns above the fund’s mandate or above the investor’s alternative (i.e., the market portfolio).  Naturally, alpha would look different from the manager’s vs. the investor’s perspective.

If you’re looking for a document that weaves together central facets of alpha-centric investing (portable alpha, 1X0/X0, fees, alternative betas, metrics etc.), and like us you don’t get excited about pages and pages of Greek letters, then we recommend this 15 page walking tour of alpha-land.

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