Considering risk factors and extending beta exposures to nontraditional asset classes could result in investors capturing alpha, Towers Watson has said.
The firm argued investors could tap into the space between alpha and beta to secure returns normally acquired by active management.
“Monitoring and selection of betas is very important—a form of alpha in itself,” –Towers Watson.
“The terms ‘alpha’ and ‘skill’ are often used synonymously, and investors have often outsourced alpha generation to specialist fund managers,” Towers Watson said. “However, we think there is an opportunity for investors to capture new sources of returns—or beta—by applying governance, or skill in a broader sense.”
According to the report, investors should adopt a broader framework for beta by using implementation strategies—such as carry, momentum, and value—and by extending beta to diversifying asset classes the likes of currency, commodities, and volatility.
These alternative betas feature great diversification capabilities, especially to traditional asset classes, displaying low correlations to equity and credit markets, the report said.
A typical alternative beta portfolio would consist of both long and short strategies, resulting in low exposures to traditional markets, Towers Watson said. It would also be scaled for risk and diversity and have low management fees.
Despite the advantages of this so-called "smart beta", the firm said it also required additional up-front governance and investor skill.
“Monitoring and selection of betas is very important—a form of alpha in itself,” the report said. “[Alternative beta] creates an opportunity for investors that have or want to develop the skills to captures these sources of return.”
The development of smart beta would prompt a reevaluation of active management and alpha, the report argued. Investors should reassess both alpha and beta sources in returns and ensure their managers focus on true alpha generators.
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