investment professionals at the 2006 National Strategic Investment Dialogue
came up with some depressing results: only 60% of them could define what "leverage"
is, and less than half could define "portable alpha".
On the one hand, it’s easy to say that if you can’t define relatively basic
buy-side terms like these, you shouldn’t be in the business. On the other hand,
I’ve tried my hand at such definitions myself, and it’s harder than it looks.
Here’s my attempt at defining "portable alpha"; it assumes, of course,
that the concept – which is based on something called the Capital Asset
Pricing Model – actually makes some sense.
Institutional investors want to invest with people who use skill (or "alpha")
to beat the market. Hedge funds and other alternative investments often have
very high alpha – but the problem is that they have no correlation with
the market that the investors want to beat. A portable alpha strategy gives
investors broad exposure to whatever markets they want, while layering select
fund managers’ alpha on top.
The definition of "leverage" is left as an exercise for the reader.