Sunday, November 3, 2019

Portable Alpha - It can be generated with alternative risk premia


Portable alpha strategies are fairly old and have been used extensively to generate excess returns versus a benchmark with limited tracking error. Recent developments in the delivery of alternative risk premia through swaps make this concept fresh and offers investors a new opportunity to enhance their equity portfolios.

Portable alpha can come in a number of forms, but one simple but effective approach is to replicate a benchmark through the futures market but use alternative collateral as a a means of return enhancement. Assume that the SPX can be replicated with futures. $100 mm in SPX exposure can be obtained through futures and the collateral can be invested in fixed income assets that exceed the risk-free rate of return. The added yield will "enhance" the return on the index minus the cost of index replication. The investor now has an enhanced return with almost no tracking error versus the benchmark. However, there are more choices available to investors.

Given that alternative risk premia can be executed through total return swaps, their return streams can be blended with an equity benchmark to create a portable alpha strategy. The steps for the portable alpha strategy are straight-forward.


  • Find an appropriate benchmark which can be traded in the futures. This is not a requirement but provides the simplest case.
  • Build an alternative risk premia portfolio that has a low correlation with the benchmark and can be executed through total return swaps. 
  • Blend the benchmark with the ARP swap portfolio to target an excess volatility or tracking error against the benchmark. A low correlation between the benchmark and ARP portfolio will allow the ARP portfolio to potentially add return without significantly increasing the benchmark risk. 
  • Measure the excess return versus the benchmark against the added volatility to find an appropriate excess return versus portfolio tracking error.
  • Measure the collateral needed for the swap portfolio and find the margin necessary to ensure that there is still full exposure to the benchmark.
  • Form a structure that will allow for the joint holding of swaps, futures, and cash equity exposure.
  • Track and monitor portfolio for deviations from expected return and risk.
There are obvious more details with implementing any portable alpha strategy but the concept of blending uncorrelated assets through swaps and futures is an appropriate way of improving a benchmark portfolio return profile.


2 comments:

Anonymous said...


Your recipes for success all presume a cyclical view of time (fixed laws of nature and repetition of events). You'd enjoy Gould's book "Time's Arrow, Time's Cycle."

Your view of time and nature as repeatable leads you to create recipes for success. A recipe from Lombardi, the football coach. A recipe from, who was it, Honda? A recipe involving portable alpha. Just follow these steps and...

But time's not a cycle and there are no fixed laws. Those notions are human metaphors for our experience.

ARP's have eroded with time. What happened to the size premium (the one that no one mentions any more)? What happened to value? Just what excess return are you talking about? Low vol? Good luck.

ARP returns are too widely dispersed. They depend heavily on the implementation details. Diversifying out the implementation details is expensive.

And besides, we don't know future *conditional* correlations. You could be adding beta, not removing it.

Example of the problem: What happened to the investor who did a value overlay 10 years ago? Where will the low vol investor be 10 years from now?

Read Gould's book.

Mark Rzepczynski said...

thanks for the recommendation. There is no question that making good investment decisions are difficult. I have not cracked the code. See my recent post on kind versus wicked environments. I offer some rules and checklists as a way of coping with the problem. I cannot say that it will solve all problems but I have found checklist and process have worked for me.