Session 11 Equity

I have little problem understanding the alpha and beta separation approach. Can anybody make it clear for me ?

Alpha - active management by selecting specific securities. Tracking risk is added. Beta - Passive management. Only market risk, ie, ‘beta’ because you are indexed. No or little tracking risk. Mix and match these two approaches according to your desired tracking risk. Any comment…

Your question can be interpreted in lots of different ways. I can explain the idea of separating alpha (creating portable alpha). If you believe a stock is undervalued and buy it you are still exposed to systematic risk (beta). By hedging the systematic risk (sell futures, etc) you can create a product (portable alpha) that has no systematic risk and can be added (and add value) to any portfolio. Does that help?

maratikus Wrote: ------------------------------------------------------- > Your question can be interpreted in lots of > different ways. I can explain the idea of > separating alpha (creating portable alpha). If > you believe a stock is undervalued and buy it you > are still exposed to systematic risk (beta). By > hedging the systematic risk (sell futures, etc) > you can create a product (portable alpha) that has > no systematic risk and can be added (and add > value) to any portfolio. Does that help? please do explain portable alpha and maybe also currency overlay in more detials. i always get it mixed up myself as well

I am still confused about the portable alpha.

Okay, I’ll take a stab: 1) Alpha is defined basically as the difference between the manager’s performance and the associated benchmark. Right? So Return = alpha + beta 2) Let’s say that portfolio is an equity portfolio and that investment manager “ABC” is really good at generating alpha, because of a sound investment process, predictive model, analytical strength, etc. 3) But what if you didn’t want the equity market exposure (i.e. the returns, volatility, characteristics) and wanted it to act like a fixed income portfolio but wanted to keep the alpha? 4) Hence you would be shorting the equity exposure via index futures and going long on the interest rate futures for whatever fixed income benchmark you wanted. (Return = alpha + beta (fixed income) - beta (equity))

Thanks Sha-you made it clearer for me.

sha_carsie Wrote: ------------------------------------------------------- > Okay, I’ll take a stab: > > 1) Alpha is defined basically as the difference > between the manager’s performance and the > associated benchmark. Right? So Return = alpha + > beta > 2) Let’s say that portfolio is an equity portfolio > and that investment manager “ABC” is really good > at generating alpha, because of a sound investment > process, predictive model, analytical strength, > etc. > 3) But what if you didn’t want the equity market > exposure (i.e. the returns, volatility, > characteristics) and wanted it to act like a fixed > income portfolio but wanted to keep the alpha? > 4) Hence you would be shorting the equity exposure > via index futures and going long on the interest > rate futures for whatever fixed income benchmark > you wanted. (Return = alpha + beta (fixed income) > - beta (equity)) Hey, I think in the context of portable alpha, the definition of alpha and beta have a different meaning. alpha simply means the source of return and beta means where the risk will take place. i don’t think you would say alpha is defined as excess return in the context of portable beta

Additionally, the source of alpha itself has a risk

whystudy Wrote: ------------------------------------------------------- > > > Hey, > > I think in the context of portable alpha, the > definition of alpha and beta have a different > meaning. alpha simply means the source of return > and beta means where the risk will take place. > > i don’t think you would say alpha is defined as > excess return in the context of portable beta I could agree with your high level philosophy - in essence the representative alpha is derived from unsystematic risk while your beta in essence represents your systematic exposure. My example speaks to repositioning your systematic risk while maintaining your alpha source. Can you clarify what you mean by your last sentence? \

sha_carsie Wrote: ------------------------------------------------------- > whystudy Wrote: > -------------------------------------------------- > ----- > > > > > > Hey, > > > > I think in the context of portable alpha, the > > definition of alpha and beta have a different > > meaning. alpha simply means the source of > return > > and beta means where the risk will take place. > > > > i don’t think you would say alpha is defined as > > excess return in the context of portable beta > > > I could agree with your high level philosophy - in > essence the representative alpha is derived from > unsystematic risk while your beta in essence > represents your systematic exposure. My example > speaks to repositioning your systematic risk while > maintaining your alpha source. > > Can you clarify what you mean by your last > sentence? > \ For example, if an institutional client wants to invest directly in commodities but cannot due to constraints, the client can do so through portable alpha to get exposure to commodities. It can hire a manager that manages commodities and at the same time use futures to eliminate all of the commodity market (systematic) risk. Thus leaving only the manager’s ability to generate return; this source of return (exposure) would be called “alpha”. So alpha does not mean excess return, it just simply means the source of return, cause the manager’s ability to pick in itself has additional risk.

The reason why portable alpha is so sought aftter is because it can potentially improve any portfolio. Investors don’t look for it to gain exposure to a sector but rather to improve the risk-adjusted performance of their portfolio.

maratikus Wrote: ------------------------------------------------------- > The reason why portable alpha is so sought aftter > is because it can potentially improve any > portfolio. Investors don’t look for it to gain > exposure to a sector but rather to improve the > risk-adjusted performance of their portfolio. portable alpha is used so that a client can transport it’s alpha somewhere else and gain additional alpha… so it can gain expsoure to a sector, as mentioned, the systematic risk can be neutralized. he can even use hedgefund as a way to port it’s alpha

whystudy Wrote: > > For example, if an institutional client wants to > invest directly in commodities but cannot due to > constraints, the client can do so through portable > alpha to get exposure to commodities. It can hire > a manager that manages commodities and at the same > time use futures to eliminate all of the commodity > market (systematic) risk. Thus leaving only the > manager’s ability to generate return; this source > of return (exposure) would be called “alpha”. So > alpha does not mean excess return, it just simply > means the source of return, cause the manager’s > ability to pick in itself has additional risk. Yeah, I agree. I see your logic too. It’s isolating the non market factored return from the overall portfolio. Would one dare call it market neutral then?

Well - I wouldn’t call it market neutral per se You are essentially trying to capture the alpha (excess return over benchmark return) of an investment manager. So to capture this you are shorting the benchmark return. So lets say +$100 invested in Alpha Source -$100 (notional) Short Benchmark Index Futures (you have to post margin on the Futures Contract) +Cash ($100-Margin Requirement) Invested in a Fixed Income Beta Source So you are not market neutral because you have the Fixed Income (or whatever you choose) Beta exposure. Beta does not equal zero. You have just stripped out the Beta from the Alpha manager so all you are left with it Alpha (so market nuetral in that respect, but not overall portfolio).