What is a portable alpha investment strategy?

Question

I think you start with an index and use derivatives, but I am not sure about the execution.

Answer 1

Alpha is supposed to be excess return without risk. People pretend that it is riskless -- but it often carries some kind of risk.


For example, most of the time people create alpha by buying less liquid securities and short-selling more liguid securities to get rid of the market risk.

A couple examples of this are buying convertible bonds and shorting the underlying stock -- or buying illiquid stocks and hedging with S&P futures.

Once you have this alpha, you can make it portable by dropping it into a portfolio of other securities.

One well known example was the Smith Breeden S&P 500 Equity Fund. They didn't actually have any equity in it. The bought mortgage backed securities (MBA) and then used interest rate derivatives to get rid of the interest rate risk. Because the MBS were less liquid, they paid a premium. This created an Alpha. They then bought S&P futures so that the beta of the portfolio was one. This fund tracked the S&P well -- usually outperforming it because of the "portable" alpha.