Portable Alpha - PowerPoint PPT Presentation

1 / 19
About This Presentation
Title:

Portable Alpha

Description:

Portable alpha, portable beta and their roles. Pension fund ... positive expected returns (compared to alphas which are generated at another's expense) ... – PowerPoint PPT presentation

Number of Views:337
Avg rating:3.0/5.0
Slides: 20
Provided by: kelin
Category:
Tags: alpha | alphas | betas | portable

less

Transcript and Presenter's Notes

Title: Portable Alpha


1
Portable Alpha
Chris BriseboisApril 4, 2006
2
Table of contents 
  • The shift in investment paradigm
  • Portable alpha, portable beta and their roles
  • Pension fund experience with porting strategies
  • Implementation issues
  • Governance issues
  • Conclusions

3
The shift in investment paradigm The traditional
approach
  • A two stage process policy and implementation
  • Determine the strategic asset allocation (SAA)
  • Identify the policy benchmark
  • Create manager mandates from the benchmarks
  • Hire managers to add value over the benchmarks

4
The shift contdWhats wrong?
  • Pension fund risk and return are dominated by
    markets manager contribution is minimal
  • Funds aren't compensated appropriately for risk
    taken
  • Periods of low or negative returns create funding
    problems
  • Benchmarks typically include a number of
    duration, inflation and currency exposures that
    are not expected to be rewarded
  • Extreme concentration on benchmarks and limited
    breadth of manager skill
  • Alpha and beta are not well balanced

5
The shift (cont'd)An alternative approach
  • Separate liability management from asset
    management
  • Separate alpha and beta
  • Overlay liability matching portfolio with an
    absolute return portfolio
  • Construct absolute return portfolio by porting
    alpha and beta

6
Portable alpha, portable beta and their roles 
  • What is portable alpha?
  • The removal of market exposure to isolate manager
    skill
  • Importance of portable beta
  • Whenever manager skill opportunities are
    attractive but the asset class is not

7
Portable alpha contd
  • What is portable beta?
  • The addition of pure beta to an absolute return
    portfolio so alpha and beta can compete side by
    side
  • Why?
  • Some betas provide positive expected returns
    (compared to alphas which are generated at
    another's expense)
  • Betas increase investing capacity
  • Betas can provide additional opportunity for
    alpha breadth (e.g. TAA)

8
Portable alpha (cont'd)
 BENEFITS
 CHALLENGES
  • Duration, inflation and currency exposures can be
    managed more precisely
  • More breadth
  • The balance between alpha and beta drivers is
    explicit
  • Implementation
  • Governance
  • Costs  

9
Portable alpha (cont'd)
10
Pension Fund experience with porting strategies 
  • U.S.
  • JP Morgan May 2005 study of 125 largest DB plans
    ("New Sources of Return Survey")
  • 28 have used portable alpha strategies, both
    outsourced and constructed internally
  • 36 are considering using these strategies
  • Surprisingly
  • 7 aren't familiar with the term "portable alpha"
  • 45 aren't using derivatives
  • Only 36 use leverage through debt-financed real
    estate or to gain notional market exposure
    through derivatives

11
Pension Fund experience contd
  • Canada
  • Minimal use to date, the most being outsourced
    product for enhanced index returns
  • Hedge funds, representing a particular type of
    portable alpha (whether standalone or in an
    overlay), represents just over 5 of total
    investments (1)

(1) The 2005-2006 Russell Survey on Alternative
Investing
12
Pension Fund experience (cont'd)
  • Watson Wyatt Experience
  • Replacement of traditional ALM studies with risk
    budgeting which does not limit decisions to the
    old paradigm
  • Portable alpha assignments conducted around the
    world (except Hong Kong) with the most in the UK
    (29 in 2004)
  • Canadian portable alpha work
  • Longest mandate has a four year history long
    bond beta portfolio and a market neutral fund of
    hedge funds
  • To date hedge funds have been used as the alpha
    source but exploring new alphas such as
    "diversity portfolios
  • Allocations have started at 5 but moving
    towards 25

13
Pension Fund experience (cont'd)
  • Examples of porting alpha and beta
  • Alpha from an area where manager skill can make a
    difference (e.g. small cap, global bonds, hedge
    funds)
  • Beta from a market that has a positive expected
    return and can provide capacity (e.g. domestic
    bonds, US large cap)
  • Examples
  • Universe bond beta with a global bond alpha
  • SP500 beta with US small cap alpha
  • Any futures strategy backed by hedge funds
    instead of cash

14
Implementation issues
  • Matching portfolio
  • Estimates for matching
  • Method for matching (e.g. cash flows)
  • Degree of matching
  • Time horizon of the match (typically 30 years)
  • Absolute return portfolio
  • Identifying a wide range of alpha sources
  • Ensuring diversification when alpha returns and
    correlations are difficult to estimate and
    stability is low
  • Fee levels eroding the return potential

15
Implementation issues (cont'd)Practical issues
with the absolute return portfolio
  • Pooled funds make implementation easier but have
    more governance issues
  • Managing derivative and leverage exposures
  • Special risks such as illiquidity, counterparty,
    capacity and erosion of alpha
  • Skill level for selecting and monitoring
    synthetic instruments
  • Ability of custodian to handle new instruments
    and strategies
  • Hedging out unwanted beta exposure may not be
    possible
  • Setting the right time horizon and expectations
    for success (i.e. alpha doesn't always perform)

16
Governance issues 
  • New skill set for all fiduciary groups
  • Monitoring and evaluating indirect investments
    through swaps and other derivative arrangements
  • Evaluating performance relative to liabilities
  • New mindset
  • Positions on transparency, leverage and where the
  • Managing the pension fund as a special type of
    hedge fund
  • Changing the degree of delegation and respective
    duties of different groups
  • Changing policy guidelines!

PRACTICAL GOVERNANCE STRUCTURES ARE WELL SUITED
TO THE CURRENT INVESTMENT PARADIGM BUT ARE AN
IMPEDIMENT TO AN ALTERNATIVE APPROACH
17
Conclusions
  • The alternative approach to managing investments
    through portable alpha and beta is better than
    the traditional approach BUT the governance
    issues are considerable
  • This approach is becoming increasingly popular as
    evidenced through transitional activities of more
    matching portfolios (still mostly just longer
    bonds) and portable alpha in return enhancement
    strategies
  • Huge opportunity , and challenge, for investment
    managers and pension fund fiduciaries
  • Governance budget will become important as part
    of the change

18
Questions for the audience 
  • Is portable alpha only a theoretical concept?
  • Is alpha really just beta that we've yet to
    identify?
  • Is it easier to predict manager skill than it is
    to predict market returns?
  • Do we have the right governance structure to
    shift paradigms?
  • Going forward, how do we ensure governance
    structures will accommodate evolving requirements?

19
Questions
Write a Comment
User Comments (0)
About PowerShow.com