CIO Magazine provides a different perspective on alpha and beta. It presents a hierarchy for alpha and beta-based trading. This hierarchy of investment skill can be viewed on two dimensions. The number of managers competing and the price elasticity or sensitivity of prices for a specific type of trading which tries to extract value. An inelastic return source will be more unique and sustaining.
All managers can generate or access the risks associated with pure beta. At the other extreme, pure alpha is a unique investment skill and is limited to a few. These represent the top and bottom of the pyramid. The space between pure beta and alpha is where most money managers battle for excess return and is also the areas which are harder to define and measure. An investor's job is to separate or understand how these investment skills can be differentiated.
Slightly more difficult to access than pure beta is alternative beta which is associated with different risk premiums. This would include small firm effects, perhaps momentum, value, and carry strategies. These strategies are well-defined. Rarer are inaccessible risk premiums which may be limited to fewer investors because there are structural or regulatory reasons why everyone cannot access. These returns are not a function of skill as much as positioning in the marketplace. A barrier to entry may not be an investment skill, but can still be beneficial.
All managers can generate or access the risks associated with pure beta. At the other extreme, pure alpha is a unique investment skill and is limited to a few. These represent the top and bottom of the pyramid. The space between pure beta and alpha is where most money managers battle for excess return and is also the areas which are harder to define and measure. An investor's job is to separate or understand how these investment skills can be differentiated.
Slightly more difficult to access than pure beta is alternative beta which is associated with different risk premiums. This would include small firm effects, perhaps momentum, value, and carry strategies. These strategies are well-defined. Rarer are inaccessible risk premiums which may be limited to fewer investors because there are structural or regulatory reasons why everyone cannot access. These returns are not a function of skill as much as positioning in the marketplace. A barrier to entry may not be an investment skill, but can still be beneficial.
Transitional alphas are excess returns which are temporary because of a change in the marketplace. The Volcker Rule or changes in the repo market may allow some to profit temporarily while the market is in transition. Since there may not be barriers to entry, this alpha will eventually be bid away. Manufactured alpha is generated when risks are structured or packaged to allow access which is not generally available to most investors. Mortgage and REIT products are a manufactured alpha which is provided to investors. It can also be a source of unique risks.
I do not fully agree with the return pyramid, but it does provide a simple framework for determining what value-added managers may provide to investors. Alpha is not always associated with skill. This is not bad, but should be recognized. Investors should seek and pay a premium for skill but should not confuse structural issues or risk premium capture for pure investment skill.
I do not fully agree with the return pyramid, but it does provide a simple framework for determining what value-added managers may provide to investors. Alpha is not always associated with skill. This is not bad, but should be recognized. Investors should seek and pay a premium for skill but should not confuse structural issues or risk premium capture for pure investment skill.
No comments:
Post a Comment