Q: equitizing a long-short vs. alpha and beta separation

Hi all, I’m hoping someone can clarify my understanding of the differences (if any) between equitizing a long-short portfolio and using an alpha and beta separation approach. Both strategies seem to use long-short positions to gain alpha, then add index funds, ETFs or derivatives to gain beta exposure to a broader market index. I’ve reprinted below the LOS relevant to my question. Thank you for your time. LOS 33.n: Explain how a market-neutral portfolio can be “equitized” to gain equity market exposure and compare and contrast equitized market-neutral portfolios with short extension portfolios. LOS 33.t: Explain alpha and beta separation as an approach to active management and demonstrate the use of portable alpha.

The two are very similar if not identical to me The only difference that I see is a perspective one ( and I might be wrong) In the first case you have a market neutral strategy - does not have to generate an alpha from a certain targeted source (i.e small cap companies) but to generate an overall alpha. To this you add a portfolio to get systemic return & risk. In the second case. you have a passive + active return strategy These might not be related but you could do that with 1. core & satellite 2. completeness portfolio 3.(?) separating beta & alpha - in this case you would pick an index plus choose a manager that can create alpha in a certain industry ( i.e. european small cap) To conclude the only slight difference that I see is that in one case the alpha is generated from the market and in the second case is a more specified alpha. I don’t know if this makes any sense, they are pretty close and I am pretty tired

hey hiredgun. i think i remember you from level 2. welcome back. I think when you equitize a long short portfolio, you only buy an etf or futures with the proceeds from your short sales. with an alpha/beta separation strategy, you’re not limited to that amount from short sales as you are completely separating alpha and beta. For example, getting beta exposure with an etf then separately using a long/short manager to attempt to pick up alpha… i’m not a 100% on this, but that is the only difference i could pick up.

i really need to revisit this section.

Alpha & Beta Separation You have a one large cap manager (who happens to be a passive manager) and one small cap manager (active management). You (the investor, plan sponsor, etc) decide that your small cap manager is the best at generating alpha (within sector effect) but you don’t want to be exposed to the sh!tty systematic small cap risk. You short a Russell 2000 ETF to eliminate the small cap beta exposure. You’re left with alpha exposure from the small cap manager and beta exposure from the large cap passive manager. Equitizing Long-Short Here you only have one manager which happens to be a long-short strategy hedge fund. The hedge fund manager makes numerous bets on the long and short side of the small cap equity market. The shorting is done by the manager himself as part of his investment strategy. You like the alpha that the L/S manager is generating, but you also don’t want to miss out on the beta exposure from large cap equities. You go long S&P 500 index futures to gain large cap equity systematic exposure. You’re left with the same small cap alpha and large cap beta, but with the two strategies you arrive at that point in a completely different manner.

makes sense. in the first case would they go long more than the value of the portfolio? that is the market neutral creates a 100% cash. they could go long more than that using futures, but it probably would not be consistent with the strategy. I think the strategy is adding 100% of beta return. cfasf1 was saying about the same thing

Thanks guys. I just revisited the CFAI curriculum on these topics and it’s consistent with McLeod’s comments. It helps that the discussion of equitizing a market-neutral long-short is within a section called “Active Equity Investing,” while alpha and beta separation is addressed in the “Managing a Portfolio of Managers” section. florinpop, I didn’t see any discussion regarding your question. The difference really seems to be a matter of perspective (i.e. whether you’re the manager, or rather investing with outside managers) and mechanics (i.e. equitizing your own short proceeds as the long-short manager vs. investing with an outside manager and using long- and short- index futures positions complete the position). It’s noted that the alpha and beta separation technique may allow institutional investors who have more restrictions (e.g. a pension plan) to participate in this type of strategy. I don’t expect this to be tested, it’s just a question that occurred to me while reviewing. cfasf1, yeah I really haven’t had the opportunity for AF participation since last summer, but I remember all the regulars here and am grateful for their contributions, including some pretty funny posts. You’re in San Francisco too, right? I was pleasantly surprised to see the LIII exam is actually in the city, no more trekking down to San Mateo, only to be stuck in the parking lot for an hour after the exam is over and another hour in north-bound traffic back to the city, when all you really want is to be celebrating with the friends/family you’ve been neglecting for months… Anyway, I’m excited for this to be nearly over. Good luck with your final preparations and hopefully come August, we’ll all have something to celebrate. Cheers.