What Is Portable Alpha?

Portable alpha is an investment strategy that involves separating the alpha and beta components of an investment portfolio.

The alpha component is the portion of the portfolio that seeks to generate returns through active management, while the beta component is the portion that tracks a benchmark index.

Portable alpha and generating higher returns

Portable alpha strategies seek to provide investors with the potential to generate higher returns than what can be achieved by investing in a traditional index-tracking product.

Portable alpha strategies can be used to enhance the performance of both long-only and long-short portfolios.

There are many different ways to construct portable alpha portfolios, but they all share one common goal: to decouple the return streams of the alpha and beta investments in order to achieve higher overall returns.

 

Portable alpha theory

The portable alpha theory was first popularly introduced by Goldman Sachs in the early 1990s.

The idea behind portable alpha is that the returns of a portfolio are determined by two factors:

  • the underlying investment strategy (alpha) and
  • the market movement of the underlying assets (beta)

By separating these two return streams, investors can theoretically achieve higher returns than what would be possible by investing in a traditional index-tracking product.

The portable alpha strategy has been popular with institutional investors, such as pension funds and endowments, for many years.

However, it is only recently that portable alpha products have become available to retail investors.

Portable alpha strategies can be used to achieve higher returns than what would be possible by investing in a traditional index-tracking product.

 

Portable alpha’s decline in popularity in 2008

Portable alpha fell out of favor in 2008 as most investment managers who used it did poorly during the financial crisis.

While alpha strategies are supposed to be uncorrelated to the broader market, sometimes that’s easier said than done.

Despite its decline in popularity, portable alpha remains an important tool for institutional investors and remains in popular use during the 2020s, used by some of the largest hedge funds and institutional investment managers today.

 

Portable alpha and derivatives

Derivatives such as options are one tool that traders can use to obtain alpha in a market.

They can use options to design very specific exposures that can’t be obtained with basic beta strategies.

 

Portable alpha strategies

The most popular portable alpha strategy is known as the ” beta and alpha replication strategy.”

This approach involves investing in a portfolio of stocks that mimic the performance of a benchmark index, such as the S&P 500, and then overlay an alpha-seeking investment, such as a hedge fund or market-neutral strategy, to generate returns that are not correlated with the market.

Other portable alpha strategies include:

“Beta neutral portable alpha”

This approach invests in both long and short positions in order to cancel out the market exposure of the underlying beta investments.

The goal is to generate pure alpha returns that are not impacted by market movements.

“Alpha portable”

This strategy seeks to invest only in highly-concentrated portfolios of securities that have the potential to generate significant alpha returns.

Investments are selected based on fundamental analysis and a bottom-up approach.

“Portable alpha with options”

This strategy uses options to generate alpha returns while also hedging away market risk.

 

The Benefits of Portable Alpha

There are many potential benefits of portable alpha strategies, including:

  • The ability to achieve higher returns than traditional index-tracking products
  • The potential to generate pure alpha returns that are not impacted by market movements
  • The ability to hedge away market risk
  • The ability to use a variety of portable alpha strategies to suit different investment objectives

However, it is important to remember that portable alpha strategies come with their own set of risks and challenges.

 

Conceptualization of Portable Alpha

Below shows a graphical depiction of portable alpha from investment manager BlackRock.

Example implementation and expected return of a portable alpha strategy

Example implementation and expected return of a portable alpha strategy

 

Traditional long-only results compared to a portable alpha approach

 

Hypothetical annual alpha generation based on approach

Hypothetical annual alpha generation based on approach

 

Comparing results of a traditional long-only and portable alpha approach

 

Hypothetical annual alpha generation based on approach

Hypothetical annual alpha generation based on approach

 

Conclusion

Portable alpha can be used to achieve higher returns by decoupling the return streams of the alpha and beta investments.

This strategy can be implemented using a variety of different securities, including options.

Portable alpha is an investment strategy that can offer many benefits, including the potential for higher returns, pure alpha returns, and hedging away market risk.

There are many different portable alpha strategies that can be used to suit different investment objectives.

 

 

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