Alpha and Beta, and the Search for a True Measure of Manager Value
While asset allocation is basically the process by which an investor allocates assets between investments based on expected risk and return, much of investment analysis is centered on the determination of which individual investments, portfolios, or asset classes may offer superior returns to other comparable securities, portfolios, or asset classes. Chapter 3 concentrates on reviewing the principal tools (alpha and beta) by which we attempt to determine fundamental asset risk as well as the ability of managers to create value. We show that even in the simple world of single -factor risk models (standard deviation, skewness, market beta) as well as in more complex models of risk and return determination, the risk models themselves may get in the way of understanding the fundamental risks we face.
In short, there is hidden risk in assuming that we know how to define risk. There is also what we term model risk imbedded in the actual models that we use for risk estimation or manager alpha determination. For instance, we show that most single-factor risk based models provide only a limited means of exploring asset risk or of determining true manager alpha. As an alternative, we explore the use of multi factor as well as simple replication/tracking approaches to determine the additional value that a manager may bring to the investment process.
WHAT IS ALPHA?
In most investment seminars and conferences, ...