Portable Alpha Theory and Practice What Investors Really Need to Know

by Callin, Sabrina; Gross, Bill

Edition: 1st

ISBN13: 9780470118085

ISBN10: 0470118083

Format: Hardcover

Pub. Date: 2008-04-04

Publisher(s): Wiley

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Summary

As an original innovator of the portable alpha concept, PIMCO has been managing an increasing number of different portable alpha strategies for investors since 1986. And now, with Portable Alpha Theory and Practice, the PIMCO team shares their extensive experiences with you. Filled with in-depth insights and expert guidance, this reliable resource provides an informative look at portable alpha and key related concepts, as well as detailed discussion on the many ways it can be applied in real-world situations.

Author Biography

Sabrina C. Callin, CFA, CPA, is an Executive Vice President and head of the StocksPLUS product management team responsible for PIMCO's global portable alpha–based equity business. Ms. Callin is joined in authoring this book by a number of colleagues with deep expertise in key areas associated with the portable alpha investment application, and who have, on average, more than eighteen years of investment experience. PIMCO currently manages over $55 billion in integrated portable alpha strategies and is generally credited with being an original innovator of the concept.

Foreword	p. ix
Preface	p. xi
Acknowledgments	p. xv
Overview of Book and Key Concepts	p. 1
Borrowing to Achieve Higher Returns	p. 3
Leverage-The Good, the Bad, and the Ugly	p. 4
The Confusion Surrounding Alpha and Beta	p. 7
Portable Alpha Definitions and Trends	p. 9
Back to the Basics: Investments 101	p. 10
Asset Allocation and Portable Alpha	p. 10
Alpha, Beta, and Alpha-Beta Separation	p. 11
Global Sources of Portable Alpha, Associated Risks, and Active Management	p. 11
Derivatives-Based Beta Management	p. 12
Portable Alpha Implementation	p. 13
The Real Holy Grail: Risk Measurement and Management	p. 13
Liability-Driven Investing	p. 14
Portable Alpha Theory and Practice: Wrapping It Up	p. 14
Portable Alpha Definitions and Trends	p. 15
The Value of and Components to Porting Alpha	p. 16
The Derivatives-Based Market Exposure (Beta)	p. 20
The Alpha Strategy	p. 21
Common Misperceptions	p. 22
The Evolution of Portable Alpha	p. 24
A New Paradigm?	p. 28
The Importance of Return-And Risk	p. 30
Conclusion	p. 38
Back to the Basics: Investments 101	p. 39
The Optimal Investment Portfolio	p. 40
Utility Functions and Risk Aversion	p. 41
Portfolio Selection and the Efficient Frontier	p. 42
The Capital Market Line	p. 45
CAPM and Factor Models	p. 47
The Benefits of Diversification	p. 48
Risk Premiums	p. 49
Theory versus Reality	p. 51
Conclusion	p. 57
Option Pricing	p. 58
Merger Arbitrage Example	p. 61
Asset Allocation and Portable Alpha	p. 65
A World of Lower Returns	p. 66
The Classic Model for Portfolio Construction	p. 69
Challenges with the Classic Model	p. 70
Portable Alpha, Level One	p. 71
Portable Alpha, Level Two	p. 73
Pitfalls of Porting	p. 75
Risk Budgeting: An Imprecise Science	p. 77
Sustainable Spending in a Lower-Return World	p. 79
The Constituent Parts of a Spending Policy	p. 80
The Risk Premium and the Building Blocks of Return	p. 81
The Role of Alpha in Setting Expectations	p. 81
Contributions	p. 82
The Implications of a Slender Risk Premium	p. 83
Stocks for the Long Run?	p. 84
Dividends and a Slender Risk Premium	p. 86
Benchmarking at the Portfolio Level	p. 87
In Search of a Better Risk Measure	p. 88
What Is Success?	p. 90
Conclusion	p. 93
Alpha, Beta, and Alpha-Beta Separation	p. 95
Beta and Alpha Defined	p. 96
CAPM, Alpha, and Beta	p. 97
Alpha and Beta in a Portfolio Evaluation Context	p. 98
The Relevance of Alpha versus Excess Return	p. 100
Key Challenges of Alpha-Beta Separation and Estimation	p. 101
Alpha Is Not Alpha without Beta	p. 104
Porting Can Be Costly	p. 105
Is the Alpha Actually Alpha?	p. 109
Beta + Beta (+ Beta ...) + Alpha?	p. 117
Conclusion	p. 126
The Trouble with Alpha	p. 127
Global Sources of Portable Alpha, Associated Risks, and Active Management	p. 135
Overview	p. 136
The Equity Markets	p. 141
The Fixed-Income Markets	p. 146
Global Diversification and Currency	p. 154
Hedge Funds Strategies	p. 165
Conclusion	p. 179
Derivatives-Based Beta Management	p. 183
Securities Lending as a Form of Low-Risk Portable Alpha	p. 183
Futures	p. 185
Swaps	p. 189
Beta Management: Basis Risk	p. 192
Examples of Proactive Beta Management	p. 194
Beta Management: Operational Risk	p. 198
Recommendations	p. 199
Conclusion	p. 201
Portable Alpha Implementation	p. 203
The Alpha Strategy	p. 204
The Derivatives-Based Market Exposure (Beta)	p. 205
Liquidity for Margin or Collateral Calls	p. 205
Consolidated Risk Management, Monitoring, and Reporting	p. 211
Integrated Approaches	p. 214
Segregated Approaches	p. 215
Semibundled Approaches	p. 216
Comparing and Contrasting Different Approaches	p. 218
Implementation Costs	p. 219
Evaluating Portable Alpha Implementation Approaches	p. 220
Conclusion	p. 221
Segregated Portable Alpha Case Study	p. 221
The Real Holy Grail: Risk Measurement and Management	p. 225
Identifying Risks: Alpha, Beta, and Leverage	p. 226
Liquidity and Correlation	p. 229
The Consequences of Leverage	p. 233
Stress Testing: Measuring Risk in Portable Alpha	p. 235
History and Time Horizons	p. 240
Conclusion	p. 241
Liability-Driven Investing	p. 243
What Is LDI?	p. 244
Less Room for Complacency	p. 249
Examining the Liabilities	p. 252
Liability-Driven Investing	p. 255
Case Study: Into Phase III	p. 263
Beyond LDI: Incorporating Factors outside the Pension Plan	p. 267
Conclusion	p. 269
Building Better Betas through Financial Engineering	p. 269
Portable Alpha Theory and Practice: Wrapping It Up	p. 273
Ability to Borrow through the Derivatives Market Sets the Stage for Portable Alpha	p. 274
Central Underpinnings to Modern Portfolio Theory Are Highly Relevant	p. 275
Alpha and Beta-It's the Combination That Matters	p. 276
A Wide Variety of Alpha Sources Are Available	p. 278
The Key Is Identification, Measurement, and Diversification of Risk Factors	p. 279
It's Important Not to Lose Sight of the Policy Portfolio	p. 280
Prudent Derivatives-Based Beta Management Is Not Free	p. 281
Portable Alpha Implementation Can Be Complex and Costly	p. 282
Risk Management Is a Critical Component of Success	p. 282
Portable Alpha Is Also Valuable for Investors Focused on LDI	p. 284
Portable Alpha Provides Tools for Better Investment Results	p. 285
Epilogue: Portable Alpha-The Final Chapter: Schemes, Dreams, and Financial Imbalances: "There Must Be More Money"	p. 287
Risk Asymmetries: Volatility, Spread, Leverage	p. 290
Absolute Return Dynamics	p. 293
The U.S. Current Account Deficit, War, and Hedge Funds: Briefly	p. 295
Public Policy Implications	p. 297
Conclusion	p. 297
Notes	p. 299
Bibliography	p. 303
About the Authors	p. 306
Index	p. 311
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