Portable Alpha Investment Strategy

Max sent to the stock group an article related to portable Alpha investment strategy. I thought that the efforts are good for portfolio managers. Here I just want to clearly understand the problem first. Below are some thoughts I have about Alpha or Beta.

RP - RF = Alpha + Beta * ( RM - RF )

RP = Portfolio Return
RM = Market Return
RF = Risk-free Return
Alpha = Constant
Beta = Constant

Based on the above theory, one can increase his portfolio return by either increasing Alpha or Beta. Beta is associated with covariance and standard deviation. Beta is a measure of risk.

Statistically, Alpha is just an error term. If the market is efficient, the Alpha's among various portfolio managers would have a probability distribution similar to standard distribution (Gaussian distribution). If some managers can consistently have positive Alpha's, then the market efficiency assumptions must be questionable.

Practically, Alpha can be considered as a measure to compare portfolio manager's quality. If one can increase Alpha without increasing Beta, he/she would be a great manager. When Beta increased, the risk is also increased. On a risk-adjusted framework, the increase may be meaningless for some investors.

Over all, the market is not-yet 100% efficient. That's why some manager can have consistently positive Alpha’s

This was prepared on June 30, 2006