Chapter 18. The Fallacy of Portable Alpha
MARKP. KRITZMAN, CFA
President and CEO, Windham Capital Management, LLC
With the assistance of
PAUL A. SAMUELSON, PhD
Institute Professor Emeritus, Massachusetts Institute of Technology
Abstract: Portable alpha is a set of security holdings representing a group of active bets whose weights sum to zero. Because the weights sum to zero, portable alpha does require capital, hence its portability. Many investors believe that separation of alpha from beta improves portfolio efficiency. This widely held belief is false if the alpha is generated from securities already contained in the portfolio. Portable alpha has the potential to improve portfolio efficiency only if it is imported from securities not already included in the portfolio.
Keywords: portable alpha, alpha, capital asset pricing model, self-financing, portfolio efficiency, geometric mean, power utility, constant relative risk aversion, log-wealth utility, expected utility, Sharpe ratio
The purpose of this chapter is to analyze the impact of portable alpha on portfolio efficiency. Suppose, for example, we believe our stock manager is skilled but our bond manager is not, and we desire a balanced portfolio of stocks and bonds. Conventional wisdom dictates the following course of action. Fire our bond manager and index the bond component of our portfolio. Convert our active stock portfolio to an index fund. Instruct our stock manager to convert her stock holdings to a portable alpha and extend ...
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