Investing - Alpha & Beta

31-05-2017 09:43:10

There are many approaches to investing capital in the market. The overall objective being the portfolio should withstand time of uncertainty and generates returns better than a benchmark of the investor’s choice. The benchmark can be different for different investors (one investor may want to beat inflation, another may want to generate returns equal to or better than equity market index). Every investor also typically has a maximum loss threshold in mind, for example an investor may not want to lose more than 10% of his capital at any point.

With the above objectives in mind, when capital is put to work, returns are generated through two components:

- Alpha component: Alpha typically refers to the excess return one generates above a benchmark. Alpha can be generated from strategies which are correlated with markets or independent of market movements. Long short investment and statistical arbitrage are a few examples which have low to zero correlation to markets and are pure alpha strategies. Discretionary long stock portfolios have mid to high correlation to markets and here Alpha is mixed with beta and achieved through the fund manager’s skills in stock/security selection.


- Beta component:  The beta component of the portfolio is the component which is correlated with the market. This may be desirable for some investors who are assessed based on their performance viz-a-viz index returns. This portfolio component however, by definition is linked with overall markets and will underperform in bear markets (assuming long net portfolio). Sometimes it’s desirable to eliminate beta.


Between a pure alpha portfolio (e.g. arbitrage strategies) and a pure beta portfolio (e.g. index ETF), there are various possible mixes. For example, a manager who is looking to beat the S&P may use an approach called “Smart Beta” to reduce portfolio constituents. A long only manager may use short positions to eliminate the beta component from his/her stock picks and thus generate pure alpha.  In general, Alpha and Beta both remain present, unless one specifically chooses to eliminate either one (typically possible by using quant strategies)


At Wealthwyse, we have several strategies which are pure alpha and there are also strategies which generate alpha but also have a beta component. Alpha strategies are typically mid to short term (1-3 months), while the beta strategies are more long term (6 months – 3 years). The advantage of this approach is that we can knowingly choose the type of exposure we want to take and decide allocations to pure alpha or alpha + beta strategies.