The past few decades have witnessed the evolution of the alternative investment industry into a serious contender in the investment world. At times, however, alternative fund clients are frustrated by high levels of advisory fees and low levels of transparency. Quantitative firms in particular have become known as “black box” investments employing strategies that are often shrouded in secrecy. An inevitable aging process has brought maturity to the industry, with a few key firms emerging to join the ranks of traditional asset managers. This process has spawned a new style of investment known as Alternative Beta, employing strategies formerly labelled “alpha”, but now relabelled and remarketed as a form of “beta” with appropriately lower fees and higher levels of transparency. These strategies frequently exhibit low correlation to standard asset classes and investments such as equities and bonds, and also offer a high level of liquidity, robustness and simplicity. These new products therefore offer added value to fee and transparency sensitive investors looking to diversify their portfolios.

CFM has more than 20 years of experience in researching financial markets and developing quantitative strategies. The purpose of this note is to introduce our approach to Alternative Beta investment, which has led to the launch of the CFM ISDiversified program. We begin by defining Alternative Beta investment before turning our attention to how we implement the systems and portfolios in practice. We also discuss the benefits of the CFM ISDiversified program in the context of a simple portfolio of benchmark investments.

We will address the following themes:

  • We begin by defining Alternative Beta strategies as a systematic approach to capturing persistent behavioural biases and alternative risk premia, which often make up the “building blocks” of hedge fund strategies.
  • We outline key selection criteria for the inclusion of individual strategies in the program, noting that persistence and statistical significance are more important than recent good performance.  A careful selection process is a critical part of the mandate of an Alternative Beta manager. Six initial strategies of CFM ISDiversified are briefly presented in this context.
  • We discuss implementation practices that we believe to be crucial in effectively exploiting strategies with relatively modest Sharpe Ratios. Because Alternative Beta strategies are often well-known, we consider implementation to be a key differentiator between managers.
  • Finally, we close by examining some of the benefits of a diversified Alternative Beta portfolio. Specifically, we show that diversifying across strategies improves both the risk-return and the skew-return profiles of the program, and that as a result of low correlation, allocating to a diversified Alternative Beta program significantly enhances the performance of a traditional balanced, or 60-40 benchmark, portfolio.

We limit ourselves to two Greek letters – α (alpha) and β (beta) – and provide a short glossary of lesser known terms at the end of the note.

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CAPITAL FUND MANAGEMENT LLP (CFM)
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