A manager finds a capable active manager in Japanese markets (TOPIX). How is it that shorting a futures position in TOPIX and going long in SP 500 futures equates to a portfolio that is SP 500 Index plus alpha associated with the Japanese portfolio? Wouldnt the manager have to actually invest in the Japanese Managers portfolio? Is there another trade in this besides only shorting the futures positions in TOPIX and going long SP 500 Index Futures? Can someone explain this to me like I am in 4th grade? From CFAI page 261 Reading 32
Any stock has a systematic risk component ( beta) and an alpha . Japanese stock has a beta to Japanese TOPIX. You want to capture only the alpha and eliminate the Beta altogether. Go Long the stock and short a futures position as proxy for the index. You will have only the alpha and eliminate the beta risk. Now you want to introduce the S&P 500 beta , just go long the S&P 500 beta. So u need 3 transactions: Long stock, Long S&P futures = Alpha of stock and Beta of S&P Short TOPIX futures = Eliminate systematic risk of Stock
^ what he said.
very nice and well explained. I thought there was another trade in there I was missing. Thanks Jana