Monday, December 1, 2008

Portable Alpha -- Another Innovation is Tested in Real Markets

Today's WSJ discusses how the Pennsylvania State Pension Fund got burned using a "portable alpha" strategy.  Titled 'Alpha Bets Turn Sour' the focus is on Pennsylvania where hedge fund bets are trailing the market by 15%.
The main idea of portable alpha is that a pension fund that uses the S&P, for example, as a benchmark, can replicate the S&P using futures and other derivatives, freeing up cash to invest in hedge funds that produce pure alpha.  Alpha being positive expected returns uncorrelated to the general market.
Some pension funds have management with the skills to deal with the sales side of this stuff.  There are a lot of pension funds that simply aren't up to it.  The theory can be taken care of in a power point pitch in a couple of hours.  But there is a lot of execution risk when people start substituting derivatives for traditional assets.  This doesn't show up in the power points.  

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