By definition, Alpha is a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a portfolio and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha. Simply stated, alpha is often considered to represent the value that a portfolio manager adds or subtracts from a fund's return.
With the very definition of alpha in mind, should an investor choose to allocate their portfolio to managers that have the potential to thwart potential market selloffs, or excel during market rallies? The answer isn't always easy; it lies in the details, and the penalties for choosing wrong can be severe. An alpha "creator" is almost always a maverick; a manager willing to make unpopular decisions to forge their portfolio strategy based on a market hypothesis. Putting your faith and hard earned dollars in ones' hands can be difficult, many facets immediately come to mind regarding risk management, portfolio strategy, asset class, or past performance. Another key consideration for selecting an alpha creating manager is how much you are willing to pay in fees, since any cost associated with the strategy will be lopped off the top of your total return.
I tend to lean towards fixed-income managers for alpha creation since the sheer size, number of securities, and the opaqueness of the bond market allow for price and value dislocations that can be more easily monetized. However, competition is fierce, and size does matter, so selecting a manager that can be nimble is prudent, especially in specialized sectors where there are very few issuers.
A question that I get asked quite frequently is how many positions should I carry? Or how much of my portfolio should I tilt towards alpha creators? I always put my reply in the same context, the more alpha creators you have on your staff, the more your returns will begin to revert back towards the benchmark index returns. Since at different times one manager might be long, while the other short. Whatever benefit there was to receive was simply wiped out by the friction, or disagreeing views of the respective managers. Three of my favorite fixed-income alpha creators and their flagship strategies are:
- Jeffrey Gundlach, CEO and CIO of Doubleline Capital, the DoubleLine Opportunistic Credit Fund (NYSE:DBL).
- Dan Ivascyn, Managing Director at PIMCO, The PIMCO Dynamic Income Fund (NYSE:PDI).
- Scott Minerd, CIO at Guggenheim Partners Investment Management, the Guggenheim Strategic Opportunities Fund (NYSE:GOF).
I have chosen each respective manager and their strategy based on a measure of past performance, strong risk management, portfolio adaptability, and reasonable fees. I believe that each of these managers will continue to generate alpha well in excess of their respective portfolio benchmarks, and provide those investors that trust their guidance with healthy returns.
Disclosure: I am long PDI, DBL, GOF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.