Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 32 Portfolio Management, Alpha, and Beta

Two of the most central issues of this book are return, as represented by alpha, and risk, as represented by beta. This chapter provides concluding discussions regarding the portfolio allocation and management of alternative investments within the context of alpha and beta.

32.1 Alpha and Smart Beta

Strategies that actively pursue alpha and strategies that passively index using a market-capitalization weighting scheme may be viewed as opposite ends of a spectrum. Increasing attention has been devoted in recent years to smart beta strategies that may be viewed as lying between active alpha strategies and passively indexed strategies. Smart beta is the strategy of implementing a rules-based portfolio weighting scheme based on one or more characteristics in the underlying assets that generates portfolio weights that differ from a market-capitalization weighting scheme. The objective in implementing a smart beta strategy is to generate an improved combination of risk and return relative to a market-capitalization weighting approach by forming a portfolio that over-weights those systematic risk exposures that are perceived to offer superior risk-adjusted returns.

Smart beta strategies utilize portfolio weights that are objectively linked to one or more measurable characteristics of the underlying assets. Characteristics used to determine equity portfolio weights can be based on any fundamental or technical attribute of an asset, ...