Toby Goodworth

Independent investment consultancy bfinance has released a new paper focused on Portable Alpha, highlighting a notable resurgence of this strategy as institutional investors seek to enhance returns and improve capital efficiency without disrupting core market exposures.

The new paper, authored by Toby Goodworth, Managing Director, Head of Liquid Markets, and Chris Stevens, Senior Director, Diversifying Strategies, explores the role portable alpha is increasingly playing in helping investors enhance return potential from liquid assets without disrupting strategic beta exposures. It highlighted that the current visible universe of portable alpha products could be up to four times larger if all proposed or in-development strategies were brought to market.

Toby Goodworthsaid: “We’re seeing a strong acceleration in appetite for portable alpha, and importantly, that demand is being met with supply-side innovation. As investors face mounting pressure to make liquid assets work harder, these solutions provide an efficient route to incorporate uncorrelated alpha without compromising on core exposures.”

Once the preserve of large, sophisticated investors with bespoke infrastructure, portable alpha has become significantly more accessible. Managers are increasingly offering turnkey structures—such as portable alpha share classes or dedicated funds—that eliminate the need for complex overlays or collateral management by the investor.

Chris Stevens added: “One of the most interesting developments is how much more accessible portable alpha has become. Where this approach was once a niche option, we’re now seeing scalable, off-the-shelf offerings that suit a much broader range of institutions.”

The paper also offers historical context, looking at the pitfalls that challenged some portable alpha strategies in the years preceding the global financial crisis. It highlights how lessons around leverage, liquidity, and correlation have been absorbed in today’s more risk-aware implementation landscape.

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Toby Goodworth

Following the considerable market losses endured in the first half of 2022, bfinance outlines that investors are taking the opportunity to weigh their own results and reassess resilience. Portfolio diversification, ‘defensive’ factors, ‘market-independent’ strategies and more explicit forms of protection such as risk overlays are all under scrutiny, with H1 bringing some notable disappointments as well as successes.

Managing Director, Head of Liquid Markets at bfinance, Toby Goodworth, discusses how classic diversifying and defensive strategies have not all provided the support that investors typically hope for in bfinance’s latest insights piece, Portfolio Protection and Overlays: Time for a Rethink?

CTAs and Macro hedge funds have delivered exceptionally strong performance year-to-date: the SocGen CTA index is up more than 20% in H1, with more trend-heavy strategies delivering over 30% on average. Many fixed income portfolios have of course been battered by rising rates. ‘Min vol’ did deliver, but ‘quality’ equity factors—typically thought to be defensive—have underperformed.

Equity risk overlays have yielded significant benefits for many investors over the past couple of years. It is, however, far from straightforward to implement a strategic approach in this area that works over the long term. Those that take on the burden of funding tail protection strategies without thorough long-term commitment at all levels of the governance structure may find themselves suffering the same fate as CalPERS, whose team abandoned its protection measures just before the COVID crisis and lost out on well over a billion dollars in returns as a result.

There are, however, many different approaches to equity risk overlay management. They range from cheaper static protection programmes through to more complex dynamically managed strategies that may include implicit long volatility trading strategies alongside explicit (paid-for) protection.

Overlay programmes, by their very nature, should be highly customised to the specific investor’s needs, exposures and risk tolerance: these are not commoditised off-the-shelf solutions. In addition to using these measures for equity risk control, investors can also use overlays across a range of asset classes for a variety of risk-reducing or alpha-generative purposes, such as tactical asset allocation and currency risk management.

There are, we believe, six questions that investors should consider before pursuing an equity overlay programme. Anecdotal experience indicates that, where these questions are not addressed internally (or where there is considerable disagreement over the answers), attempts to implement programmes will often flounder.

Six portfolio protection questions to address

1. Which exposures are to be protected?
2. What range of losses are we protecting against?
3. What type(s) of drawdown are we protecting against?
4. When do we want protection to start and finish?
5. How much are we prepared to pay?
6. What instruments or asset classes should be permitted?

While investors do not need to have fully defined views on all six of these questions up front, honest discussions about them among the investment team, risk team and board will lay the groundwork for making robust, well-supported decisions. While advisors and overlay providers can help investors to define their views on these points—like architects designing a home extension—it is important to ensure that guidance is closely aligned with investors’ specific needs, tastes and cost sensitivities.

Overlays are not for everyone. And they should not be used as a sticking plaster for strategy: it is always crucial to address whether the underlying exposures and the approach to strategic/dynamic/tactical asset allocation are actually appropriate before attempting to modify them through overlays. In the right context, however, they can represent a valuable portfolio construction tool.

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