Portable Alpha
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Portable Alpha is an investment management term which refers to the return of an investment manager who has intentionally and completely eliminated his market risk, or beta. The return of such a portfolio will only represent the manager's skill in selecting investments within the market, and will be independent of the direction or magnitude of the market's movement. The elimination of market risk can be accomplished through use of futures, swaps, options, or short selling.
See Alpha for a definition of alpha.
Here, Portable Alpha implies that the extra returns (alpha) can be separated from the changes of the market by hedging the market exposure of the portfolio.
The process of Portable Alpha is also sometimes referred to as Alpha Transport
[edit] Example of Portable Alpha
As an example, consider a manager who invests only in small-cap US stocks, and the stocks in his portfolio have an average beta of 0.85. For the year, his portfolio declined by 5%, while the small-cap US stock market (the Russell 2000) declined by 10%. Based on his beta (market risk), his portfolio should have declined by 8.5%, but his skill in picking small-cap stocks resulted in his portfolio only declining by 5%. The difference between 8.5% and 5% is attributed to skill and called alpha. So his alpha for this year would be 3.5%.
To make this 3.5% alpha "portable," the manager could have sold Russell 2000 index futures at the beginning of the year, hedging out his exposure to the market. An investor in this type of portfolio would experience a return, not of a negative 5%, but a positive 3.5%.
[edit] Usage of a Portable Alpha manager
Institutional investors typically make use of this type of investment management as an addition to their portfolio. They gain exposure to a portfolio of their desired markets through use of passive investments, and use leverage against this portfolio to invest in the portable alpha manager. As long as the manager returns enough alpha to cover their costs of investing (interest and fees), the investor can port the excess return to his portfolio.
Because market risk is eliminated, an investor might be convinced to invest in asset classes that he may not otherwise wish to invest in, as long as the investor has confidence in the skill of the investment manager. For example, a hospital endowment's investment policy might prohibit investment in commodities, but the board might be convinced that they can circumvent this policy for a portable alpha manager who invests in commodities, because he hedges out his exposure to the commodities market.
