Alternative Investing
The Alpha in Portfolio Construction
January 1, 2013
Investments and Pensions Europe
We believe that portfolio construction, risk management and cost control are the “low-hanging fruit” of managing a long-term portfolio. We contend that the skillful combination and management of the various components of the portfolio constitute a form of alpha on its own — this is what we call alpha through portfolio construction.
Here are some specific suggestions for improving a portfolio:
- Allocate by risk, not dollars. Measuring portfolio shares by dollar allocations can mislead. The 60/40 dollar split between stocks and bonds may sound balanced but actually is roughly a 90/10 risk allocation, given the greater risk of equities.
- Ensure you are building a truly diversified portfolio. Investing in alternative portfolios that are highly correlated with the equity market only provides the illusion of diversification. Aim to assemble a portfolio of assets with high Sharpe ratios and attractive diversification abilities.
- To generate returns comparable to equities-heavy strategies, diversification almost certainly requires the prudent use of leverage, short-selling and derivatives. Such tools involve financial risks to consider, but these risks have proven to be manageable even through some vicious downturns.
- It is essential to not pay alpha prices for what is not alpha. The prospect of a prolonged period of low returns underscores the importance of cost-effectiveness, whatever returns investors are harvesting. Fair fees depend on the return source.
We also recommend that investors create a drawdown-control methodology for their overall portfolios — in short, a plan to systematically reduce risk because of losses and to add it back in a similarly systematic way as markets turn back up.
This document is not intended to, and does not relate specifically to any investment strategy or product that Belvedere offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Belvedere Advisors LLC (“Belvedere”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of Belvedere. The views expressed reflect the current views as of the date hereof and neither the author nor Belvedere undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither Belvedere nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.