Portablealpha

Key Takeaways

• Portable alpha targets higher returns by investing in assets that have little to no correlation with market indexes.
• Alpha is the excess return on an asset compared to a benchmark, while beta measures its market correlation.
• Investors can use portable alpha by balancing between large-cap stocks for beta and small-cap stocks for alpha.
• The goal of portable alpha is to boost returns without increasing the portfolio's overall risk or beta.
• Portfolio managers replicate the beta of an index and add high-alpha securities for potentially greater returns.

What Is the Portable Alpha Strategy?

Portable alpha is a strategy designed to add alpha returns without risking the overall beta of a portfolio. It calls for investing some funds in assets that have little to no correlation with the assets in the market index that's tracked by the portfolio.

A stock or other asset's alpha is its return in excess of a benchmark against which it can be compared. Its beta is a measure of its volatility over time in comparison with the same benchmark.

How to Apply the Portable Alpha Strategy

First, a couple of definitions:

The alpha of a stock or other asset is its historic return above a wider market index or another industry benchmark that it is compared with.

The beta of an asset is its volatility or its riskiness compared to a benchmark. It measures the extent to which the price of the asset moves with the market, not independently.

Choosing assets for their beta is vital in portfolio management and is often called passive returns. A stock or fund is selected because its beta indicates it will match the return of the benchmark.

Harnessing Beta for Optimal Portfolio Management

A stock or fund with a beta of 1.0 tends to move up and down with the movement of the market. A fund with a beta of 0.5 moves up and down only half as much as the market. One with a beta of 1.5 moves up and down 1.5 times as much as the market.

Important

Portable alpha can be achieved by investing in stable large-cap stocks and volatile small-cap stocks.

Therefore, beta can be said to represent passive returns or returns that result from the movement of the market as a whole.

Leveraging Alpha for Higher Returns

A second type of portfolio returns is known as idiosyncratic. These are returns that are achieved by selection according to alpha.

That is, the stocks or funds are selected because they have a history of outperforming the benchmark. This process is active management, not passive management.

Implementing a Portable Alpha Strategy

An investor can achieve portable alpha by investing in securities that are not correlated with the beta. Typically, the goal with portable alpha is to achieve a higher overall return without endangering the beta, or volatility, of the entire portfolio.

A portable alpha strategy might include investing in large-cap stocks for market returns and small-cap equities for alpha gains. Small-cap stocks are more volatile than large-cap stocks, which raises the overall beta.

To offset the higher beta, the small-cap strategy can be hedged with small-cap index futures, stabilizing the portfolio's beta.

What Does Alpha Mean in Investing?

In investing, the alpha of an asset represents its abnormal or excess returns, adjusted for risk, when that asset is compared to a benchmark or index. Active investors seek assets with a high alpha in order to generate higher-than-market returns. Alpha is usually expressed as a percentage, representing the difference between the asset's returns and the returns of the benchmark.

What Does Beta Mean in Investing?

In investing, beta represents the volatility or risk of that asset when compared to the wider market. Beta is expressed as a coefficient: a beta greater than 1.0 means that the asset is riskier than the S&P 500, and a beta less than 1.0 means that it has less risk than the wider market. The S&P 500 has a beta of exactly 1.0.

How Do You Calculate the Beta of a Portfolio?

The beta of a portfolio is calculated by averaging together the beta of each stock in the portfolio, weighted by its share of the total portfolio.1