An Overview of 'Portable Alpha' Strategies, with Practical Guidance for Fiduciaries and Some Comments on the Prudent Investor Rule

Abstract:     
This article discusses an innovative enhanced indexing strategy known as "portable alpha". A portable alpha strategy, in essence, involves overlaying the return from an external fund or internal strategy that has consistently generated alpha with a derivatives-created index exposure. A number of major fund managers in the United States and the United Kingdom have recently launched funds incorporating portable alpha strategies. Steps are also being taken to launch similar products in Australia.

The article also considers: the economic rationale for portable alpha strategies; the differences between conventional indexing and enhanced indexing strategies, on the one hand, and portable alpha strategies, on the other; the principal sources of alpha for portable alpha strategies in the United States, United Kingdom and Australia; and the different methods for implementing portable alpha strategies.

In addition, the article examines the key issues under Australian law confronting fund managers, pension trustees and other fiduciaries who are considering portable alpha strategies. A typical portable alpha strategy comprises two elements -- investing in a discrete source of alpha or implementing an alpha-generating strategy and overlaying that investment with synthetic exposure to an index created by transacting derivatives. Thus, a fiduciary must, first, have the legal capacity authority to invest in the source of alpha and enter into the derivatives. Secondly, the adoption of the portable alpha strategy must be consistent with the duty imposed on fiduciaries, by Australian law, to act prudently when investing the assets entrusted to them.

Keywords: Portable Alpha Strategies, Indexing, Mutual Funds, Hedge Funds, Prudent Investor Rule

JEL Classifications: G23, K22

Working Paper Series