4. BETA ALPHA
DEFINITION The return from the market
The excess return generated by skill of
an investment manager
DRIVERS OF RETURNS Macroeconomic factors Managers’ unique decisions
NO. OF SOURCES Relatively few Virtually unlimited
CORRELATIONS Modest Low
DISPERSION IN PERFORMANCE Relatively consistent performance Large dispersion on risk-adjusted basis
AGGREGATE CHARACTERISTICS Positive sum game across asset classes Zero sum game across managers
FORECAST RISK Low High
FEES Can be accessed for low fees Usually accessed for higher fees
Comparing Beta and Alpha
Accessing Asset Classes Efficiently
Accessing Assets Efficiently
4
6. Beta
Accessing Asset Classes Efficiently
Understanding Beta
6
Cash Derivatives
Index Funds Equity Options
Exchange Trade Funds (EFTs) Index Futures
• Active Funds – wide range of active managers.
• Part of return – also provides alpha;
• Core and Satellite structures;
• Relatively high charges.
• Index Fund - a liquid, passive investment.
• A portfolio constructed to match or track the components of a market index;
• Available across equity and bond classes;
• Provides broad market exposure, low operating expenses and low portfolio turnover.
• Exchange Trade Funds (ETFs) - a liquid, passive investment.
7. Using Call Options Original Equity Allocation
• Benefits from equity risk premium;
• Exposed to equity beta volatility that may generate
unwanted downside risk;
• Large exposure to single source of return.
Call Option Strategy
• Use of long dated call options (e.g. 10 yr):
• Captures equity premium, and;
• Matches the long dated liabilities.
Accessing Asset Classes Efficiently
Using Call Options
7
Equity
Option
9. Shortening Credit Duration
Sterling Spreads vs. Maturity (bps)Cumulative Default Probabilities on Maturity
(20)
0
20
40
60
80
100
120
0 5 10 15 20 25 30
AA
BBB
A
Source: Moody’s, Citigroup calculations.
• Comparisons of spreads and default rates by tenor would suggest:
• Shorten the corporate bond duration;
• Lengthen duration through swaps or use of Supra/Sovereigns;
• Diversify UK Gilt portfolio into alternative Supra/Sovereigns;
• Consider diversifying into structured credit solutions.
• Substantial risk savings can be achieved at limited or no cost to expected returns.
0%
2%
4%
6%
8%
10%
12%
14%
0 5 10 15 20 25 30
AA
BBB
A
AAA
Accessing Asset Classes Efficiently
Shortening Credit Duration
9
10. Traditional (Cash) Assets
• A wider selection of credit, not limited to financials and utilities.
Alternative Assets
• For example, an even wider selection of credit, i.e. loans.
GiltsCorporate Bonds
(5-10Yrs)
Swaps
Absolute Returns
Short Term
Short Term
Long Term
Long Term
Accessing Asset Classes Efficiently
Shortening Credit Duration
10
12. Accessing Asset Classes Efficiently
Removing Constraints
12
• Fund manager is better able to implement
his negative views on individual stocks in
addition to his favourable ones
NB: In practice the percentages of 130/30 can vary
according to the targeted market(s)
Equity 130/30 Fund
1. Put 100% of the capital into an
index such as a UK banking
sector index
2. Then sell short 30% in the stocks
expected to do worse than the
market
3. Use the proceeds of selling short
to go 30% long on stocks likely to
beat the index
4. This strategy can add up to 2% of
additional return whilst reducing
volatility.
• A fund manager can fully implement
both positive and negative views on
particular stocks
Equity Long/Short Strategy
1. Borrow shares
2. Sell immediately
3. Place proceeds on deposit
4. Buy back when price corrects
5. Returns shares to lender
14. Separating Two Sources of Return – Portable Alpha
Portfolio
Return
Alpha
= Beta
Market
Return
Portable
Alpha
GBP Cash
Short Beta
e.g. using
futures
GBP Cash
– + =
Accessing Asset Classes Efficiently
Portable Alpha
• Investment returns in most asset classes can be attributed to “alpha” and “beta” components.
• Beta returns are the reward delivered by exposure to an asset class, usually gained from
taking passive market exposure.
• Alpha is the return in excess of an appropriate benchmark that may be provided by active
management; it is achieved by investment or manager skill.
• Portable Alpha solutions allow the separation of these two sources of return.
• Portable Alpha allows asset allocation returns – those which result from the market’s
(beta*) – and the returns attributable to manager skill over and above market returns
(alpha*) to be captured independently of each other.
14
15. Conclusions
Accessing Asset Classes Efficiently
Conclusions
15
• The market provides a wide range of instruments that can be used to access risk and return.
• This choice provides Trustees with the opportunity to tailor their risk management policy to meet
their scheme’s specific requirements.
Two Key takeaways
• If you choose to invest passively, i.e. seek Beta then:
Invest Efficiently and Cost Effectively
• If you believe in manager skill, and thus seek Alpha, do so by:
Removing as many constraints as is consistent with your Risk Budget
16. Contacts
Dawid Konotey-Ahulu | Partner Direct: +44 (0) 207 250 3415
dawid@redingtonpartners.com
Robert Gardner | Partner Direct: +44 (0) 207 250 3416
robert.gardner@redingtonpartners.com
Redington Partners LLP
13 -15 Mallow Street London EC1Y 8RD
Telephone: +44 (0) 207 250 3331
www.redingtonpartners.com
THE DESTINATION FOR ASSET & LIABILITY MANAGEMENT
Contacts
Disclaimer
Disclaimer For professional investors only. Not suitable for private customers.
The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion
purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the
parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear
above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressed
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Please note, the accurate calculation of the liability profile used as the basis for implementing any capital markets transactions is the sole responsibility of the Trustees' actuarial
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