Portable Alpha
From Wikipedia, the free encyclopedia
Portable Alpha is an investment management term which refers to a special kind of investment diversification. For instance, a diversified stock portfolio reduces the risk of financial loss by approximating the growth of the overall stock market.
In this example, Alpha is the increased gain in value of a stock portfolio due to a manager who successfully invests in firms whose stock prices fare better than the market.
Here, Portable Alpha implies that the extra returns (alpha) can be separated from the changes of the market by actively trading in stocks which do not change the same way as the rest of the portfolio and the general stock market.
[edit] Mathematics of Portable Alpha
The strategy involves the use of active investment management to create market exposures in securities or financial instruments in markets that may be unrelated to that of the primary market exposure (or beta) of the portfolio. The active return (or alpha) generated is hence "portable" since it has been "ported" from a market unrelated to the beta.
portfolio return = α + β * market risk premium
Market Risk Premium = Expected Market Return less the risk free rate=E(Rm)-Rf
where β is the extent with which the portfolio moves with the market. The passive part of the portfolio is β and α is the active part of the portfolio, which is generated by active management techniques.
If the portfolio manager can improve alpha by investing in securities that are not correlated with the beta of the existing portfolio, that manager can create a portable alpha.
[edit] Example of Portable Alpha
A hypothetical case of a portable alpha strategy could be the following; A manager has skill in picking under/out performing stocks in Japan. However, his client prefers have an exposure to the US equity market (and particular, would like to out-perform an S&P500 index benchmark). The manager could pursue a portable alpha strategy by investing passively in the S&P500 (For example, by using futures), whilst taking "long/short" Long / short equity positions in Japanese stocks based on his stock-picking skill. Assuming this skill held up, he would then deliver a portfolio return equal to;portfolio return = α + β * market risk premium
portfolio return = α + β * market risk premium
Market Risk Premium = Expected Market Return less the risk free rate=E(Rm)-Rf
portfolio return = [Japanese stock-picking performance] + [S&P500 return]
