Portable Alpha

Portable alpha is a strategy in which portfolio managers separate alpha from beta by investing in securities that are not in the market index from which their beta is derived. Alpha is the return achieved over and above the market return (beta) without taking on more risk. In simple terms, portable alpha is a strategy that involves investing in areas that have little to no correlation with the market.

Portfolio returns come from two sources. The first source is systematic and is often referred to as beta. Beta is the extent to which an investment vehicle moves with the market and is therefore also a measure of volatility. A fund with a beta of 1.0 moves 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, and one with a beta of 1.5 moves up and down 1.5 times as much as the market. Beta can be said to represent passive returns, or returns that result from the movement of the market as a whole.

The second source is idiosyncratic, specific to the movement of individual stocks (or other securities). This is represented by alpha, which is a measure of returns resulting from selecting some securities over others, or from other forms of active management.

A portfolio manager can achieve portable alpha by investing in securities that are not correlated with the beta. Typically, the goal with portable alpha is to achieve this alpha without affecting the beta, or volatility, of the overall portfolio.

A portable alpha strategy, for example, might involve investing in large cap stocks to get the beta or market return, and investing in small cap equities to achieve alpha. But since small caps are more volatile than large caps, the overall beta will be higher. To neutralize this higher beta, the small cap strategy could be hedged with futures on a small cap index, thereby returning the beta of the overall strategy, large caps and small caps, to its original level.