By Roger G. Clarke, Harindra de Silva, Steven Thorley
By way of studying the small avalanche of white papers, magazine articles, books, and different assets of knowledge on alpha-beta separation, the authors offer an target resource of rules, terminology, present perform, and implementation concerns on alpha-beta separation for the institutional funding group, fairly 401-k sponsors, foundations, and endowments.
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Additional info for Investing Separately in Alpha and Beta
Sample text
The optimal weights of pure-alpha funds (assumed to be uncorrelated with each other and with the various beta funds) are based on their information ratios and levels of active risk. , domestic and international equity) but can be derived from a matrix of covariance assumptions or forecasts by using well-known portfolio optimization procedures. 7. When alpha and beta risks are uncorrelated, optimal weights of the various alpha funds are independent of the weights chosen for the beta or index funds, which are established by the overall allocation of beta risk.
2. But even this optimal mix of actively managed funds does not allow for the possibility of separating the alpha and beta components of each fund. We now introduce the possibility of a derivatives overlay on each of the managed funds, whereby both the hedge ratios and the fund weights are flexible (not fixed, as they are with no derivatives overlay) and are chosen to optimize the overall portfolio Sharpe ratio. Using Equations C4 and C5 in Appendix C, we 9 Ex post information ratios, used in performance attribution, always vary from zero except in the unlikely circumstance that the manager had exactly the same return as the benchmark.
From a financial economics perspective, the momentum factor is suspect given the lack of a clearly defined and nondiversifiable risk factor, as required for a positive risk premium in equilibrium models. Although financial economists ©2009 The Research Foundation of CFA Institute 33 Investing Separately in Alpha and Beta acknowledge the impressive historical performance statistics of momentum, they generally attribute the phenomenon to behaviorally induced market inefficiencies or regard it as simply an exercise in data mining.