No Mobility With Portable Alpha

I went down a portable alpha rabbit hole. We've discussed it plenty, using the terms capital efficiency and return stacking more often that portable alpha. It is essentially using leverage to add exposure beyond a 100% portfolio. Portable alpha a little more specifically is the matching up of beta (simple market exposure like via an index fund) with an alpha seeking strategy. Here's a video from AQR to explain it better than I can, that assumes a "top quartile hedge fund" for the alpha seeking component. 

Here's an old paper from Cambridge Associates looking at portable alpha. They list out some different ideas to consider for the alpha component.

• Catastrophe bonds
• Legal claims
• Global macro 
• Fixed income arbitrage
• Fixed income relative value
• Commodity pairs trades
• Ultrashort duration fixed income
• Direct lending 
• Harvesting the option volatility risk premium

There are some asset classes we look at regularly in the list and several we never have looked at. I modeled out six different portable alpha ideas using funds we've talked about before. Each one is levered up 50% allocating 50% to ProShares Ultra S&P 500 (SSO) which equals 100% into the S&P 500 and then I put 50% into the funds as labeled on the images. SSO has been imperfectly close to twice the S&P 500 far more often than not but of course looking forward, the imperfect closeness could completely unravel. The new Tradr ETFs we've talked about might do a better job with longer term tracking. 

The green line on both charts benchmarks the S&P 500. They all outperform but all but one also dial up the standard deviation versus the S&P 500. Three of the six offer slight improvement in risk adjusted return. Only two of the six, the one with QLEIX and the one with LFMIX. were down less than 15% in 2022. While some of the individual funds have offered crisis alpha in the past, that wasn't necessarily a benefit the way we constructed the portable alpha ideas for this post. Three of the six were down more than the S&P 500 in 2022.

We've talked countless times about using leverage to leverage down. All of these clearly leverage up and do so without helping on a risk adjusted basis. When we do these exercises we see that sometimes the leverage boosts returns a little but not always. For my money there's not much of a basis to think this idea can reliably add alpha. When we leverage down though, we regularly see more meaningful improvement in lower volatility and much better risk adjusted portfolio results than going the leverage up route. 

It's not that this doesn't work, more like it is difficult to make it work with funds available to retail sized accounts. With retail accessible funds, we've had far better luck pulling a little from equity and a little from fixed income, or maybe a lot from fixed income, to make the portfolio more robust. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.