Another Examination Into Portable Alpha

The investment theory of “Portable Alpha” is predicated on the understanding that investors can combine, or “port,” returns achieved through active management with returns resulting from broad-based market exposure, thus out-performing the markets in general.

I obviously believe this is very possible, not only for institutional managers and hedge funds, but for private investors as well.

But rather than use sophisticated investments such as options and equity swap agreements along with leverage to provide cheap market exposure and “beta,” I think investors can use index correlated exchange traded funds that basically provide the same exposure and are much easier to trade.

Take the current markets for example. I think that investors wanting broad-based market exposure, which is the first component of a portable alpha strategy, should look to the NYSE 100 (NYC), S&P 100 (OEF) and S&P 500 (IVV). These are the only “buy” recommended major market index derivatives at the moment, based on our proprietary analytics, yet they provide investors with sufficient market exposure at a relatively low cost.

The Russell 1000 (IWB) and the Dow Jones U.S. Total Market (IYY) derivatives are strengthening, but we see these indexes as “neutral” investments, which means “hold” rather than “buy” or “sell.” We need these indexes to pass several independent technical indicators prior to being upgraded to “buy” status.

Additionally, we continue to observe weakness within the S&P 600 (IJR) and S&P 400 (IJH) indexes, although neither is “sell” recommended.

From there, investors should look to establish the “active management” portion, the second component of a portable alpha strategy.

Start first with style-box investments, such as Large Cap Value (JKF), which our analysis indicates is the strongest currently. Large Cap Growth (JKE) and Large Cap Core (JKD) investments are beginning to generate alpha, but I recommend patience until they strengthen further.

Next, narrow the active management strategy down further into specific sectors and/or industries. Real Estate (IYR), Software (IGV), Utilities (IDU), Technology (IYW), Healthcare (IYH), Semiconductors (IGW), Telecommunication (IYZ) and Non-Cyclicals (IYK) are the top alpha-generating sectors and are all recommended “buys” in this morning’s newsletter.

Finally, select specific stocks or funds from within those sectors or style-box’s that you’re comfortable actively managing.

For example, since Large Cap Value investments are doing well currently, I might look to Symbol Technologies (SBL), Equity Residential (EQR) or Advanced Micro Devices (AMD), all of which are Large-Cap Value companies that fall within one of the above sectors.

I realize that this strategy might seem foreign to some investors, especially those that have spent years utilizing a buy-and-hold approach. Some people just don’t want to actively manage their investments, which is perfectly fine if you’re willing to accept average returns.

But if you accept the theory, which more and more investors are doing, and are willing to do a little of the work yourself, then the next logical step is learning how to do it. To give you a better idea, check out our latest archived newsletter, especially the Market Overview and Portfolio Builder pages.

Actively managing an investment portfolio and generating portable alpha for yourself really is much easier, and cheaper, than you think.