James Picerno had an interesting post at his site the Capital Spectator. He explored the extent to which investors add value to their portfolios by managing betas, not by trying to add alpha--he even serves up a quote that theorizes "that there are no alphas...only betas we know and betas we have yet to identify."This is a little fuzzy to me frankly but beta is simply an exposure. Equities are a beta, commodities are a beta as is every asset class that might go into a reasonably diversified portfolio. So "managing betas" means that an investor is adding value by knowing when to underweight equities and overweight commodities and being correct about it (just an example not a forward looking statement). IMO an example of successfully managing betas could be someone taking defensive action in late 2007 by heeding the 2% rule (market averages a 2% decline three months in a row as evidence a bear market has begun).
To the extent that a decision to reduce long exposure for whatever reason and doing so correctly is adding alpha by managing betas then I am on board with that part of it. As far as no alphas well first, I just disagree with that. But the next question to ask is whether or not stocks from other countries comprise a distinct asset class from domestic stocks. This can be in the eye of the beholder but I don't think that Latin American stocks, for example, are a distinct asset class--it is a region not a different asset class. Again though, there can be more than one right answer. Similarly I don't think debt from Thailand is a different asset class from treasuries. Both are fixed income exposure with some different characteristics and variables to be analyzed but it is all debt.
If a country is a different asset class then a correct decision to add Switzerland, just an example, becomes managing betas and if a country is the same asset class then it is a source of alpha. What about sectors? Are they asset classes? I say no but either way a sector is either a beta to be managed or a potential source of alpha. Anyone who decided to avoid tech eleven years ago or avoid financials three years ago added alpha--I can't recall ever reading that those particular trades were not alpha generators but whatever.
Back to no alphas, assuming I understand the comment, and why I disagree; well the points above about countries and sectors rely on them not being separate asset classes. But as a different type of example take a portfolio benchmarked to the S&P 500. Instead of buying SPY an investor chooses a starting point of equalweighting each of the ten big sectors against the index meaning that if energy is 12% of the index then the portfolio buys 12% of XLE. At this point a portfolio like this has merely copied the index expensively and no alpha generation is possible.
As I said though equalweighting with sector funds is just a starting point. Now assuming the builder of this portfolio did not buy XLE at the start of the year but instead bought Ecopetrol (EC). YTD XLE is down 3% and EC is up 62%. That one trade is an alpha generator. The portfolio, with EC in for XLE, would have picked up 7.80% against the S&P 500 (EC would have added 7.44% plus adding back in the 0.36% loss that would have been incurred in XLE).
That example is not particularly subtle. Some subtler examples could include decisons about yield, volatility, style and market cap.
James concludes with an optimistic viewpoint about investment products, mostly ETPs, allowing investors easier access to more betas, errrr asset classes, like currencies, bonds from around the world, commodities, sectors in China and a slew of other things. WisdomTree just launched the Commodity Currency ETF (CCX) which is a way for people to access a lot of world, without equity risk, that I think is important--fair warning I have not looked at the fund yet.
As useful as the ETPs are I would also urge investors to make use of individual issues, stocks and fixed income, too. I feel very confident about country and niche exposure being very important going forward as they were in the recent past. As I have mentioned before I do not think another sector will get bigger than 20% of the S&P 500 for along time after happening twice in the last ten years.
On an unrelated note a reader at Seeking Alpha left the funniest heckle since I started blogging on my post during the week that included a mention of StairMaster machines;
Certainly you could afford to belong to a gym that has more than 2 Stairmasters - is your business that bad?
Maybe the reader really meant it but I thought it was world class funny.
5 comments:
"that there are no alphas...only betas we know and betas we have yet to identify."
I think anyone who writes articles like these should be required to pull out their Finance 101 textbook and review the CAPM and work a few practice problems.
The CAPM was built using MPT whose fundamental concept is that the assets in an investment portfolio cannot be selected individually. The whole efficient market concept is routinely rejected here, so why does everyone use models that whose assumptions rest on it? There is always talk of "black swans" but MPT assumes predictable correlation and perfectly normal distributions.
These types of articles are a bunch of nonsense.
Roger,
in making a portfolio do you consider a high beto or low beta stocks?
Jeff from Milan, Italy
yes Jeff I do. in the article I mention managing the volatility as possible being a subtler way to add alpha
PBR has lost approximately the same amount in market value from December 09 till date as the additinal equity the company is raising. Does it mean that PBR is in a better shape today than what it was in Dec 09.
At some point, will you also consider adding TBT (ultra short 20 year treasure) to your portfolio? What are some of the triggers that will let you make the decision? As waiting for Fed to increase the rates will mean that TBT has already captured most of its upward gains.
Please discard these questions if you feel that they are too specific (in your terms - handing over fish - instead of teaching to catch fish).
Thanks a lot.
the maturity and duration of our fixed income portfolio is so short that TBT would not offer much of a hedge; more like a chance to speculate which I am unlikely to do on the fixed income side.
i am not that close to PBR but it diluted itself after it dropped a lot? seems rather uncompelling.
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