What Is the Portable Alpha Strategy?
The portable alpha strategy focuses on investing in stocks or other assets that have demonstrated little or no correlation with the markets. To do this, investors separate alpha from beta by investing in securities that are not in the market index from which their beta is derived.
- 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.
- Portable alpha is a strategy designed to add alpha returns without risking the overall beta of the portfolio.
Alpha is the return achieved over and above the market return (or beta) without taking on more risk. Thus, portable alpha is a strategy that involves investing a portion of assets in assets that have little to no correlation with the market.
Understanding Portable Alpha
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.
Selecting assets for their beta is a key strategy in portfolio management. These are sometimes referred to as passive returns. A stock or fund is selected because its beta indicates it will match the return of the benchmark.
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.
Portable alpha might be achieved by devoting one portion of a portfolio to steady large-cap stocks and another portion to more 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.
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.
Using Portable Alpha
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 involve investing one portion of the portfolio in large-cap stocks to get the beta or market return, and another portion in small-cap equities to achieve alpha.
Since small-cap stocks are more volatile than large-cap stocks, the overall beta will then be higher.
To neutralize this higher beta, the small-cap strategy could be hedged with futures on a small-cap index, thereby raising the beta of the overall portfolio to its original level.