E22. Alpha Unchained: What the Data Says About Portable Alpha's Institutional Moment - Descript

Corey Hoffstein: 00:01:18

Welcome everyone.

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My name is Corey Hoffstein.

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I am the CEO here at Newfound Research

and co-founder of Return Stacked ETFs,

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and I am absolutely delighted and

excited today to be joined by Shane

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McCarthy to discuss the state of the

portable alpha, or as we like to call

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it, the return stacking landscape.

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Shane is the global head of

the client and partner group

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at Lab Quantitative Strategies.

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LABQs is a Denver based quantitative

asset manager They spun out of one of the

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world's largest family offices where the

founding team managed capital at scale

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for over 15 years, and their key focus

is on portable alpha, combining diverse

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sources of alpha with capital efficient

beta in a liquid risk managed portfolio.

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Shane and I have known each other for

a couple years, but back in October,

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Shane actually opened our Return Stacking

Symposium with a presentation on the

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state of the portable alpha landscape.

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Since then, a number of consultants and

banks have released surveys of large

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pensions, endowments and family offices,

as well as other institutions on their

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use and adoption of portable alpha.

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And so, almost six months later, and

armed with this new data, we thought it

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would be a really good opportunity to

share where the industry stands today

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and the usage trends that are emerging.

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Now, before I turn it over to Shane to

begin walking through that data, I'm gonna

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start with a little bit of housekeeping.

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And with that we're gonna pop up a poll

while I talk through the housekeeping.

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this is a poll about

adoption of portable alpha.

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I assume everyone on this call has at

least a, a moderate interest, but just

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outta curiosity, we sort of wanna get a

sense of where people's interest lies.

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From a housekeeping perspective

from, for those of you who are not

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familiar with the Zoom platform,

you should see at the bottom of

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your Zoom window, a q and a button.

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This will allow you to ask

questions throughout the webinar.

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I will be keeping my

eye on those questions.

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Those that are incredibly timely,

I will try to bring up to Shane

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throughout the presentation.

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Otherwise, we will hold them and

try to address them towards the end.

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I also want to share that LABQs recently

published a white paper called Portable

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Alpha Risk First Alpha Durability.

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It's all about building resilient,

portable alpha solutions.

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You can find that on

their website, lab-qs.com

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under the media and research section.

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Okay, let's take a look at this poll.

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The poll is, are you currently

using Portal Alpha or Return

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Stacking solutions today?

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31% of you?

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Yes.

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And looking to expand usage?

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24%.

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Yes.

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Happy where you are.

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9%.

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No.

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But actively looking to add 28.

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No.

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But researching.

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Thank you for joining.

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Glad you're here.

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7% just outright, no, not sure what

you're doing on a call about portable

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alpha, but always nice to know that

there's, uh, some dissenting voices here.

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Hopefully we can convince you to move

to a No, to a no, but researching.

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Shane, ready to turn it over to you here.

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I know we've got a lot of exciting

survey data to go through before

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we go through that though.

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Again, with, uh, a variety

of folks in the audience.

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Some very familiar with Portable Alpha,

maybe some first learning about it

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and researching it for the first time.

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Can you maybe start off with a little

bit about what is Portable Alpha?

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Why are institutions turning towards

this portfolio construction technique?

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Shane McCarthy: Absolutely.

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And uh, you know, thanks

for this opportunity.

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again, my name is Shane McCarthy

and, uh, the lab portion of Lab

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Quantitative Strategies actually

stands for Liquid Alpha Beta.

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And so we are focused on this type of,

uh, portfolio construction approach.

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Um, we did spin out of the family office

a number of years ago and, uh, continue

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to manage institutional portfolios.

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What is portable Alpha is the key

question, and I actually do have a

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slide on that coming up here in a few.

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I'll start with that and then we can skip

over it as we go through the deck today.

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But tremendous opportunity.

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It's a very timely conversation.

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Um, we're seeing a lot of

oppress and research around it.

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you know, portable alpha, we think about

it as more of a portfolio construction

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technique rather than a specific strategy.

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We think about it as more of a system.

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And so included in that is there's

a beta component, let's say

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equities and a passive approach.

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There's alpha something that's UNC

correlated to equity and beta, but

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returns, you know, there's a lot

of other parts that go into it.

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It could be risk management, it could be

execution, it could be rebalancing and

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operations and collateral management.

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And basically the objective is to

separate equity beta returns, which

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are cheap and commoditize, as we all

know, from skill-based alpha returns.

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Which are more scarce and expensive.

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So we like to think about it

in more of like a simplistic

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real estate example approach.

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Um, I think we're all, you know,

personally, um, have had these types of

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experiences where you buy a home, let's

say it's a million dollars to keep it

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simple on the math, we call that the beta.

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You have two choices.

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You can pay the full amount for the,

the purchase price in cash, or you

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can put down, let's say 20%, you

can get a mortgage and invest at

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least most of the remaining amount.

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You may want to keep some around for

payments or upkeep and that sort of

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thing, but most of it you can go and

invest in something that's completely

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uncorrelated and unrelated to the

house and we'll call that alpha.

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And so your investments with that,

with that, with that unencumbered

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cash effectively needs to exceed the

financing costs of the mortgage and

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you're looking to earn that excess return.

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It's good to invest in something that's

not correlated with the home price.

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And if you do it correctly, you can

get exposure to both the house and the

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investments and allow for your dollars

to work better, uh, and harder for you.

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And so that's the idea

behind Portable Alpha.

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It's really, it's an

outcome based approach.

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And if it's structured

correctly, it can be durable.

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It could be a consistent outperformer

relative to a, a beta benchmark.

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Conceptually it's simple, but

operationally it, it's, it's anything

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but, and so we'll go, we'll, we'll go into

that a little bit more here in the deck.

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I'll talk a little bit about

what, you know, what the

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areas we're gonna cover today.

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we already covered what is portable alpha.

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We'll talk a little bit about

its positioning inside of

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a liquid market portfolio.

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Then we'll talk a little bit about

how it compares to traditional

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approaches that we commonly find

in the liquid market component.

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And then we'll jump into why Portable

Alpha, who's investing in portable Alpha,

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some of the investment choices around it

because it is a very customizable approach

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to your liquid market book, some of the

implementation choices that we're seeing

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inside of the institutional industry.

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And then lastly, just

implications for allocators in

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more before looking approach.

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So before we get into a lot of those

details, I thought it made sense.

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Just, uh, start at the big picture,

kinda the macro level and, and just

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talk about portable alpha and a

little bit, even about its history.

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It's been around since the 1980s,

so going on nearly 40 years.

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Demand in portable alpha has grown a lot.

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It did a lot in the two thousands.

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It receded a bit around the GFC and

then we saw a lot of strong interest

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over the last number of years, and

that that's reflected in the number

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of research that we see, a number

of the new structures that we see.

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And so it's definitely gaining

momentum here, the last couple years.

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Previously it was only institutional,

so it was, it requires, it's,

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it's a fairly complex operational

infrastructure and the trading behind it.

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And so typically it was more on

the pension side in the early days.

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And, and it is slowly, you know,

decade, over decade, it's grown more to

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encompass endowments and foundations.

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And now even more so in the last,

you know, last number of years.

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It's incorporating in wealth

channels and OCIO and family

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office and that sort of thing.

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You can see in the first bullet point

there that we, you know, the estimates

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around the GFC were about 75 billion.

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it did recede.

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There was some challenges with, with,

uh, during that time with portable alpha

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and we'll talk a little bit about that.

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And now we've seen a resurgence

in estimates as of today are, are

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roughly a hundred billion dollars.

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And it could be, it could be more.

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It's kind of hard to measure.

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And that kind of re relates to

the, the fragmentation point there.

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There's a whole ecosystem behind it.

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It's not necessarily a specific

type of bucket or type of strategy.

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It's more of a portfolio

construction framework and approach.

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And so it can be somewhat fragmented.

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I would say that the banks have done

a really nice job on aggregating

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research around that, talking to the

institutional allocator community.

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Some names that come to mind include

Barclay's Capital Solutions, their

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strategic consulting group, Morgan

Stanley, UBS, and a handful of others.

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They've done a nice job on that.

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It is a little bit, you know, again,

because of the fragmentation and

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how you define mandates, it can be

difficult to aggregate the overall AUM.

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Sometimes it can be double counted.

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There's things between the beta and

the alpha, on how you measure that.

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There's a lot of SMAs

and bespoke solutions.

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There's commingled solutions and

sometimes, frankly, these can be

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muddled with currency overlays or

completion account overlays to maintain

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strategic asset allocation weights.

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So sometimes it can be hard

on, on how you define it.

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I would say that the customization

around this, it, it's really the norm

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and it's really a feature, it's not a

bug and it, it is meant to, it makes

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it harder to implement, but it's, it

makes it much easier to integrate into

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a strategic asset allocation approach.

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The level of capability around

it, it's needed, to be successful.

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And again, we'll talk about that.

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There's different areas around that.

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I would say that it's penetrating a lot

of different channels though, so it's not

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a purely institutional product anymore.

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It's going into the well channels, OCIO

family offices to name a, name a few.

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And I would say that, you know, it's

been around for a long time and sometimes

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it's surprisingly misunderstood.

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So it's worth the time to get to know.

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It can be a highly effective

tool inside of a portfolio.

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I've already described

what is Portable Alpha.

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This is sort of a visual around that, to

talk about, to just kinda show the overall

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exposure, given your investment outcome.

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And then again, the allocation behind it.

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It's pretty simple.

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You have that you, you, you have

20%, let's say in an allocation

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that you keep as cash margin and you

use that to get a full a hundred.

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If you put a hundred dollars in,

you're trying to get a hundred dollars

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of equity, beta exposure, let's say,

but you only need 20 of cash margin.

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You keep a cash reserve of another 20%

and then it allows you through that

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unencumbered cash to allocate to an

alpha engine and deliver tracking error

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and excess return over the benchmark.

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Okay, so this is an important

one I thought and, and I just

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wanted to briefly touch on this.

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This is a liquid markets kind of overview

and, and we all face these types of

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challenges in the liquid market book.

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There's a ton of demands on this portion

of the portfolio and we've all experienced

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'em in a lot of different ways.

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For most allocators, this is part of

this is they're expected to do a lot.

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You have capital calls in

your private market book.

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You have client liquidity needs, you

have taxes, you have opportunistic

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trading, estate planning, a

number of different challenges.

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And so this is often treated

as like a passive exposure and

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portable alpha reframes that.

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It turns a liquid portfolio into

something that can generate additional

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return, but do it very differently

than the traditional approaches.

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And then over the last couple

years, and even in the, in the more

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recent we've seen slowing private

equity distributions, we've seen

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recent pressures in private credit.

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And so it amplifies the challenges

and the needs that we find in

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the liquid market portfolio.

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This slide here is, is really a

comparison to traditional investment

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approaches inside the liquid market book.

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And so.

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You can see there.

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The first one is you, you have an

opportunity through portable alpha

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in the techniques around it to

improve the return per unit or risk.

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Yes, an investor cannot eat sharpe, I

believe in that, but it is a powerful way

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to get more return and smooth the path.

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It's cash efficient or it's more cash

inefficiencies in a traditional approach

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with a fully funded, uh, exposures.

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And so it takes less cash to

get the same type of exposure.

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And again, that goes back to

even that real estate example

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that I brought up earlier.

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You can effectively use all those

proceeds to have home price appreciation

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and exposure there, as well as

exposure to other asset classes.

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The alpha bucket, it's very

regime agnostic, portable alpha.

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And so what does that mean?

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In a traditional approach let's say 60 40.

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That seems to be something,

an industry standard.

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No doubt it's provided strong

returns, particularly in the

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last few years since 2000.

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It's annualizing 7%.

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It's running at a 10%

volatility and about a 0.5

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sharpe.

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However, it has had three different

periods over these 25 years

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where it's down more than 20%.

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And we think that that's a key

measure on investor behavior and

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where investors potentially can make

bad decisions at the wrong time.

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So some of these drawdowns in 2022

with the inflation scare, we saw it

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down 20% in the early two thousands,

the dot com, we saw it down 22%.

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And then O, of course, in the GFC

of '07 and '08, we saw it down 32%.

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That's on a monthly return basis.

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If you measure it on a daily return,

you could add another a hundred to

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200 basis points on top of that.

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And that's a US-centric view.

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If you look at Global 60 40,

it's even a larger drawdown.

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We see that as three to 400

basis points more that we're

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realized in a drawdown over time.

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So in any event, there's no perfect

way to this, but Port portable

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Alpha can compliment what's

inside your liquid market book.

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On the behavioral bias side, everyone's

looking for beta exposure and they,

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and they also like diversifiers.

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We find that it can be very challenging on

what exposure do I want at any given time.

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There are periods where Alpha works

and there are periods where beta works

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and it can take that behavioral bias

and that decision making off the table,

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by cash efficiently combining beta

and alpha together into one portfolio.

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You can stay invested, you don't miss out.

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You can arguably reduce return,

or sorry, the risk within the

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portfolio relative to the benchmark.

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And then lastly, the excess return.

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A lot of investors and it works,

security selection, manager selection.

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It can be hard though, and we find that

a lot of times excess return generated

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by that may not be persistent over time.

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Excess return generated by portable alpha

is a completely different way of doing it.

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It's a structuring edge.

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It's allocating to assets and

trying to exceed the financing costs

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embedded with the beta exposure.

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Corey Hoffstein: To jump in here, Shane,

I saw a great quote actually earlier

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today from Justin Young at MIMCO.

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He was on a panel at a recent AQ

derivatives event, and he was quoted as

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saying, when you look at top quartile

managers in large cap US equities,

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median performance is negative alpha.

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Mm-hmm.

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Whereas if you look at bottom quartile

hedge funds, they almost all beat cash.

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Right.

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And so when you talk about where can

you generate excess returns from that

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traditional approach, it is very hard.

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Manager selection is very hard in

that very crowded part of the market.

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Even if you choose the worst hedge funds,

they generally outperform the financing

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required for portable alpha to work.

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So that's, that's right.

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That structuring advantage

you're talking about here.

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I really appreciate you setting the table,

laying that foundation for this talk.

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Now I really want to dive

into the meat and potatoes of

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what these surveys are saying.

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So I was hoping, given the context of what

Portable Alpha is and what it's trying

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to achieve, can you talk a little about,

a little bit about who is using it today

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and maybe the objectives that they're

trying to meet, why are they using it?

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Shane McCarthy: Mm-hmm.

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I'll start with the why Corey, I think

it's, it's very important to begin there.

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you know, as we talk to investors

and we, and we understand the surveys

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and the research behind it, a lot

of it is just a market backdrop.

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You know, arguably the equity markets

at the high end of the range of, from a

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valuation perspective, credit spreads are

tight and who knows where we go from here.

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But now more than ever, structure matters.

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you know, from a portfolio crowding

perspective, again, allocators

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want access to diversifying

strategies with no disruptions, and

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they have a fully deployed book.

309

: 00:19:53

So this is a way to

better manage all that.

310

: 00:19:57

On the capital efficiency side, it

just, it's a better usage of dollars.

311

: 00:20:01

It, it allows you to work harder,

arguably not take more risk.

312

: 00:20:06

And meet the challenges that we, we

talked about on that liquid market slide.

313

: 00:20:12

I think the sophistication of allocators

is just continuing to increase.

314

: 00:20:16

They think very holistically about it.

315

: 00:20:18

They think about it as a system

and a framework, and they allow,

316

: 00:20:23

they don't get so focused on if one

thing is up and one thing is down.

317

: 00:20:27

It's more of a system kind of built

together to again, generate that

318

: 00:20:32

excess return over a benchmark.

319

: 00:20:34

And then lastly is a customization.

320

: 00:20:37

The more, the more allocators

build capability, the more they

321

: 00:20:41

have a governance structure, the

more they understand what their

322

: 00:20:45

investment outcomes should be,

they're able to customize it more.

323

: 00:20:49

And that can be around the tracking

error or the volatility of the active

324

: 00:20:53

risk around that benchmark, their

overall risk, the return expectations,

325

: 00:20:59

and there's less tied to an index, they

can focus again on portfolio outcomes.

326

: 00:21:04

An integration to a strategic

asset allocation approach.

327

: 00:21:09

On the next slide,

there's actually a survey.

328

: 00:21:13

It's from UBS, about a year old now.

329

: 00:21:15

And it, it talks about, you know,

what, what are allocators looking for?

330

: 00:21:20

And it's very clear that they're looking

for excess return over an index and

331

: 00:21:25

they're looking for an operational

efficiency of a combined product.

332

: 00:21:29

And so it's very clear there, there was

actually a recent, uh, research report

333

: 00:21:34

put out by Morgan Stanley who did a

nice job, very similar type of survey.

334

: 00:21:39

And there over 60% of the participants

are looking for excess return, and

335

: 00:21:44

another 20 are looking for capital

efficiency and maintaining a be target.

336

: 00:21:49

So we find those are the two common

themes from a survey perspective

337

: 00:21:53

in the institutional space.

338

: 00:21:57

Okay, so who's investing?

339

: 00:21:59

Like I said earlier, historically

it's been institutional investors.

340

: 00:22:03

If you go all the way back to the

eighties again, it was more of a pension

341

: 00:22:06

focused, sort of a niche, approach.

342

: 00:22:09

And now it's, it's expanded

to a wide variety of channels.

343

: 00:22:14

you know, I think that these numbers show

that it's not just about adoption, but

344

: 00:22:19

it's also about the conviction of it.

345

: 00:22:22

And so institutions have historically

focused on capital efficiency and

346

: 00:22:27

portfolio construction and wealth

channels, and focused more on enhancing

347

: 00:22:31

returns without increasing the

headline risk of the overall portfolio.

348

: 00:22:36

And so you can see here we're seeing a lot

of adoption and conviction in the advisor

349

: 00:22:42

and consultant community continued in the

E&F and the pension on the institutional

350

: 00:22:47

side and all the way in between.

351

: 00:22:50

And so it, it's, it's relatively,

diversified at this point.

352

: 00:22:54

Then this, I thought this

was an interesting one.

353

: 00:22:57

This is an allocator tenure of how

long they're invested in portable

354

: 00:23:02

alpha and yeah, 40% of investors

have been in it more than five years.

355

: 00:23:08

That's great.

356

: 00:23:09

You can see that there on the right.

357

: 00:23:11

However, what I thought was most

interesting was, look at the less than

358

: 00:23:15

one year, almost 30% of the survey

said they are better understanding it

359

: 00:23:19

and now they're looking to, you know,

they, they put money to work and it's

360

: 00:23:23

still a relatively short tenure, but

they're starting to put money to work

361

: 00:23:27

there and they're understanding it.

362

: 00:23:29

So I, I thought that was interesting.

363

: 00:23:32

Corey Hoffstein: Earlier on you talked

about the customization that portable

364

: 00:23:36

alpha affords, you can sort of mix and

match different benchmarks and you can

365

: 00:23:41

mix and match different alpha sources.

366

: 00:23:43

You know, given these different

objectives though, though collectively

367

: 00:23:46

it looks like just beating the market

remains the headline objective.

368

: 00:23:50

Can you talk a little bit about,

what betas institutions are looking

369

: 00:23:55

to replace, what sort of alphas

they're using, maybe how much

370

: 00:24:00

they're introducing of those alphas.

371

: 00:24:04

Shane McCarthy: Absolutely.

372

: 00:24:06

I'll start with where they

position portable alpha.

373

: 00:24:10

So again, it's in the liquid market book.

374

: 00:24:13

We, you know, this survey here

shows that because of the beta one

375

: 00:24:17

profile, most allocators position

it as a public equity exposure.

376

: 00:24:22

Um, it approves the efficiency

of the equity allocation.

377

: 00:24:26

It can differentiate again how

you generate that excess return.

378

: 00:24:30

this is from Barclays.

379

: 00:24:32

They actually had a recent survey in

Q1 of 26 here, and it was actually

380

: 00:24:37

80% of those survey participants

view it in a public equity space.

381

: 00:24:43

So we actually see an increase

relative to this survey here.

382

: 00:24:46

And so.

383

: 00:24:48

Again, it's something where they

could position it as an alt hedge fund

384

: 00:24:52

allocation, but I think we're gonna find

that more where you have institutions

385

: 00:24:57

that are looking for higher tracking

error for whatever reason, and so

386

: 00:25:00

there's a little bit more of, it's

not behaving like an index per se.

387

: 00:25:05

Building blocks of portable alpha.

388

: 00:25:08

You know, there, the beauty of this

is that it's customizable and, and you

389

: 00:25:14

can put together, you can mix and match

different things as you model it out

390

: 00:25:20

and as you structure your portfolio

to meet your investment outcomes.

391

: 00:25:23

It's really not a one size fits all.

392

: 00:25:26

As you can see here you know, there's some

building blocks that are very familiar to

393

: 00:25:30

all of us, right across equities, whether

it's US-centric or global fixed income.

394

: 00:25:36

There's obviously you can do

single or multi-asset class.

395

: 00:25:39

You can even add in commodities and

currencies and other beta markets as well.

396

: 00:25:44

and so we find in the surveys

that, you know, US-centric

397

: 00:25:50

investors have a home bias.

398

: 00:25:52

They predominantly try to get more of

a US beta component built into their

399

: 00:25:56

portfolio, whereas the rest of the

world has more of a global mandate,

400

: 00:26:00

maybe more like a world or an ACWI.

401

: 00:26:03

Beta instruments have really,

the, the breadth of them have

402

: 00:26:07

increased over time as well.

403

: 00:26:09

And so to put on the cash efficient

beta exposure, you can do that through

404

: 00:26:14

futures, you can do that through swaps.

405

: 00:26:17

There's ETFs to name a few.

406

: 00:26:20

and then on the alpha side, you know,

I'm gonna save some of this for a future

407

: 00:26:25

slide where we're gonna talk, we're gonna

look a little bit at the individual hedge

408

: 00:26:28

fund strategies and where the demand

is across the institutional industry.

409

: 00:26:32

But these are some examples on equity

market neutral, multi-Strat trend.

410

: 00:26:37

And again, you're looking for an

alpha component that can exceed

411

: 00:26:43

your financing costs of your beta.

412

: 00:26:45

What you don't see in this slide though,

is more illiquid type of, investments.

413

: 00:26:52

And so that could be private equity,

it could be private credit, it could be

414

: 00:26:57

real estate, and that's for good reason.

415

: 00:27:00

There's a lot of risk because

there's embedded beta in there.

416

: 00:27:03

There's leverage embedded in there,

and there are illiquid structures,

417

: 00:27:07

and so there could be some,

there's some challenges to that.

418

: 00:27:11

Okay, so this is a really good survey for,

again, from UBS and it talked about what,

419

: 00:27:19

what are the, you know, the clear leaders

from a hedge fund strategy standpoint?

420

: 00:27:24

There's a range of

different opportunities.

421

: 00:27:26

The breadth of the hedge fund industry has

really grown over the last 20, 25 years.

422

: 00:27:30

So there's a, there's a number

of different types of strategies,

423

: 00:27:33

and again, you can mix and match

it in a lot of different ways.

424

: 00:27:37

Some of these in isolation though,

can actually create a lot of tracking

425

: 00:27:42

error and it can be too much relative

to what the investment outcome

426

: 00:27:46

needs to be given the allocator

and, and what they're looking for.

427

: 00:27:51

Some of them, there may not be

enough alpha in there to exceed

428

: 00:27:55

the financing cost of the beta.

429

: 00:27:57

And so again, it's the

beauty of portable alpha.

430

: 00:28:00

You can mix and match this

in a lot of different ways.

431

: 00:28:03

You can see here on the

left side that equity market

432

: 00:28:06

neutral is by far the leader.

433

: 00:28:09

Nearly 90% of the survey participants

use it in a portable alpha construct.

434

: 00:28:15

So it's the most common, it may

not be the most complete solution.

435

: 00:28:19

And we can talk a little bit

about that here in a, a few

436

: 00:28:22

minutes if, if it makes sense.

437

: 00:28:24

we think about it like, Corey, you

mentioned the Alpha Durability paper

438

: 00:28:28

that we wrote and is on our website,

and we think about it a lot in a few

439

: 00:28:33

different ways around trying to get

different properties, in equal risk

440

: 00:28:38

weighting those properties, to allow for

an alpha engine that generates a strong

441

: 00:28:46

risk adjusted return, can do it over

the financing cost of the beta, but also

442

: 00:28:52

has protection properties built in, in

the event that we see equity drawdowns

443

: 00:28:57

and we need, you know, components of the

alpha engine to, to perform at that time.

444

: 00:29:04

Corey Hoffstein: Well, I wanna, I

wanna pause on this slide, Shane.

445

: 00:29:06

because I think there's a lot

to unpack here and the types

446

: 00:29:09

of alphas people are using.

447

: 00:29:11

What this slide doesn't show and

what I haven't seen any of the

448

: 00:29:12

survey data really show is, is how

institutions are thinking about

449

: 00:29:17

combining these different alpha sources.

450

: 00:29:20

So, I wanna ask you a question and then

we've had some actually great, really

451

: 00:29:23

great questions come in through the

q and a reminder that that's there.

452

: 00:29:26

I'm gonna, I'm gonna ask two of them on

this slide 'cause I think it's relevant.

453

: 00:29:29

But I know that LABQs has adopted this

convergent versus divergent strategy

454

: 00:29:35

framework and thinking about mixing and

matching strategies that fall into those

455

: 00:29:39

two buckets from a risk perspective

and using that and blending them to

456

: 00:29:45

help meet objectives of your clients.

457

: 00:29:47

Can you talk a little bit about, maybe

give some examples of different type

458

: 00:29:50

of strategies that fall into each

bucket, why you think of it that way,

459

: 00:29:53

and how you think about combining them?

460

: 00:29:56

Shane McCarthy: Absolutely.

461

: 00:29:56

Uh, you know, like I said, we, we think

about it in having an equal risk approach

462

: 00:30:02

between convergent and divergent.

463

: 00:30:05

And so let me define those

two a little bit more.

464

: 00:30:09

So convergent, you know, if you

look at this list of strategies

465

: 00:30:13

here, we think about that as

market neutral, mean reversion.

466

: 00:30:20

It, it's basically a fundamentally driven

strategy that's designed to make money

467

: 00:30:26

under most normal market periods, which

we all find most of the time, right.

468

: 00:30:30

Where it can struggle is in dislocations.

469

: 00:30:34

And so the characteristics around

convergent are typically lower volatility.

470

: 00:30:39

It can be a higher win percentage,

but the losses are quicker and deeper

471

: 00:30:45

and it can tend to like double down

on fundamental views of fundamental

472

: 00:30:50

point of view in the event that

it goes, a trade goes against 'em.

473

: 00:30:54

So it effectively has

like concave profiles.

474

: 00:30:58

They're typically low capacity,

high alpha, high sharpe ratio type

475

: 00:31:02

strategies, but with it they can be,

they can get exposed to crowding factor.

476

: 00:31:09

De-leveraging unwinds and the, and

what we call negative skew, where

477

: 00:31:13

they can give back a lot very quickly.

478

: 00:31:15

So some examples in this slide here

would be equity market neutral,

479

: 00:31:19

fixed income, relative value,

statistical arbitrage, merger arb,

480

: 00:31:24

are a couple examples of convergent.

481

: 00:31:28

We think about that group though as

again, performing well in most normal

482

: 00:31:33

periods it's got a positive carry.

483

: 00:31:36

And in a portable alpha construct, it's

meant to exceed your financing costs.

484

: 00:31:42

On the flip side is divergent, that's a

completely different type of property.

485

: 00:31:48

We find that in trend following, there's

different flavors of global macro.

486

: 00:31:52

There can be systematic or discretionary.

487

: 00:31:55

There can be directional or

relative value, but generally

488

: 00:31:58

global macro fits in there as well.

489

: 00:32:01

And so there, it's not fundamentally

based strategies, it's based more on pure

490

: 00:32:08

price trend trending markets.

491

: 00:32:11

it's, it is got more of a, like a, what

we call a smile effect to it, and there's,

492

: 00:32:15

they're more convexity built in there.

493

: 00:32:18

And so there, they're meant to

de, they're designed to make

494

: 00:32:20

money in more stress environments

and what we call crisis alpha.

495

: 00:32:25

They typically run in a little bit

higher volatility than convergent.

496

: 00:32:28

They have a lower winning percentage,

so there's lots of small losses,

497

: 00:32:32

but at the same time, they're

systematically driven and they cut

498

: 00:32:36

risk very quickly if they're wrong.

499

: 00:32:39

And so there are more high capacity given

the types of instruments that they trade.

500

: 00:32:44

The breadth of markets can be hundreds

and hundred, hundreds of them, and

501

: 00:32:47

then they compliment conversion.

502

: 00:32:49

And that's more of a protective feature

that can be built into a portable alpha

503

: 00:32:53

program that, again, sits next to that

carry component of the convergent.

504

: 00:32:58

We blend all those together and what we're

trying to do is generate a consistent,

505

: 00:33:03

durable alpha return stream that can

outpace the financing costs and generate,

506

: 00:33:08

again, a lot of it can be dependent on

how much alpha you allocate inside of

507

: 00:33:13

your portable alpha program, but it's

very much dependent on your volatility

508

: 00:33:17

of your alpha, the sizing of your

alpha, and then again, how you mix the

509

: 00:33:21

conversion and diversion type properties.

510

: 00:33:25

Corey Hoffstein: I wanna address some

of the questions that have come up here.

511

: 00:33:27

two in particular really seem

relevant to this slide, so,

512

: 00:33:30

so I want to address those.

513

: 00:33:31

And we have a number of attendees here

who are, who are not institutional,

514

: 00:33:35

they're financial advisors and, and

wealth managers who are trying to figure

515

: 00:33:39

out how to take this concept and apply

it to clients that maybe don't have

516

: 00:33:45

this perpetual lifespan of an endowment.

517

: 00:33:49

Right.

518

: 00:33:49

Maybe are more modeled as short term

pensions to a certain degree with,

519

: 00:33:53

with some unknown flexible liabilities.

520

: 00:33:55

And, and the question here is around, you

know, if you're talking about convergent

521

: 00:34:00

versus divergent for an individual.

522

: 00:34:03

Investor, you know, would you think about

skewing, convergent or divergent during

523

: 00:34:10

different parts of their life cycle?

524

: 00:34:11

Would you think potentially about

convergent for accumulation and

525

: 00:34:15

divergent for decumulation where risk

management's a little more important?

526

: 00:34:19

And I, and I know you don't focus

specifically on the wealth channel,

527

: 00:34:22

Shane, but as someone who, who is,

you know, thinking constantly about

528

: 00:34:25

this balance of convergent, divergent,

do you have any thoughts there?

529

: 00:34:29

Shane McCarthy: It's a

really good question.

530

: 00:34:31

I, I would say that we are very

intentional in line item focused on

531

: 00:34:37

building a portfolio holistically.

532

: 00:34:40

And we don't, we don't moderate

the risk exposures between the two.

533

: 00:34:45

So again, we, we equal risk to

the two and we think that they're

534

: 00:34:49

very complimentary to each other.

535

: 00:34:52

They definitely serve different

purposes in the portfolio.

536

: 00:34:55

and so we keep it much

more of a consistent risk

537

: 00:34:58

budgeting, approach to that.

538

: 00:35:01

I guess tactically you could do that.

539

: 00:35:04

I, I, if you know that the profile

of your client I is changing over

540

: 00:35:09

time, but that, that's philosophically

from a portfolio construction

541

: 00:35:13

standpoint, that's not how we do it.

542

: 00:35:14

We, we like to keep those

attributes and those properties

543

: 00:35:18

very consistent throughout.

544

: 00:35:20

Corey Hoffstein: I'll answer

anecdotally from our side, and we

545

: 00:35:22

have a new blog post with a, a tool

embedded in it that allows people to

546

: 00:35:27

play around with some optimization.

547

: 00:35:28

But, but what we find is, you know,

for folks who are really focused on

548

: 00:35:31

generating excess returns, it, if

you run an optimization, you do not

549

: 00:35:36

get rid of divergent strategies.

550

: 00:35:37

Those divergent strategies play an

important role in, in maximizing

551

: 00:35:40

the compound growth rate.

552

: 00:35:41

And similarly, if you tilt your

objective all the way towards capital

553

: 00:35:44

preservation, which is so key for

people in that decumulation stage,

554

: 00:35:49

generating consistent excess returns the

way convergence strategies do is also

555

: 00:35:54

meaningfully important for them, right?

556

: 00:35:57

Generating a little bit of excess

turnover year gives them more flexibility.

557

: 00:35:59

So you, what I find in, in running all

sorts of scenario analysis is you never

558

: 00:36:04

really get rid of one side or the other.

559

: 00:36:06

They both play an important role.

560

: 00:36:08

one of the questions here, Shane, is on

the portable alpha building block side.

561

: 00:36:12

Has there been anything that you've

seen that's been really innovative for

562

: 00:36:15

the alpha strategies outside of, say,

multi-strat or global macro, some sort

563

: 00:36:21

of new uncorrelated strategy that's,

that's popping up more and more?

564

: 00:36:27

Shane McCarthy: Not

off the top of my head.

565

: 00:36:28

There's, there's a lot more though

from a moving away from strategy

566

: 00:36:32

implementation per se, but more

about the structuring side of it.

567

: 00:36:37

We find a lot of innovation from

the banks on how to get access

568

: 00:36:41

to the alpha return streams and

be more capital efficient there.

569

: 00:36:44

Some allocators actually want more

leverage embedded in the alpha component.

570

: 00:36:49

and so there's different

ways of going about that.

571

: 00:36:52

and so yeah, that's what we're seeing

is more, it's more on the structuring

572

: 00:36:55

side and again, to the improvement of

capital efficiency, the improvement

573

: 00:37:00

of risk management and all the tools

around the instruments that can be used.

574

: 00:37:05

Corey Hoffstein: Yeah.

575

: 00:37:05

Some of the stuff we're seeing in, in

the conversations we're having around

576

: 00:37:08

trying to find really idiosyncratic return

sources, obviously that's the holy grail.

577

: 00:37:12

catastrophe bonds potentially

as an example of, of one fairly

578

: 00:37:17

idiosyncratic return stream.

579

: 00:37:20

The where the rubber meets the road

though is always managing the liquidity

580

: 00:37:23

mismatch of how you're accessing your

beta versus how you're accessing your

581

: 00:37:27

alpha and how you can rebalance those.

582

: 00:37:29

And there's a long storied history of,

of why this approach fell out of favor

583

: 00:37:32

in 2008 because of those illiquidity

mismatches and, and misunderstanding

584

: 00:37:36

of, of correlations in the tail.

585

: 00:37:38

So, we've had some more questions pop up.

586

: 00:37:40

I'm gonna keep us moving address

those questions at the end.

587

: 00:37:43

so let's,

588

: 00:37:44

Shane McCarthy: let's, hey, can I, and can

I, just on that last point, absolutely.

589

: 00:37:47

Chime in, you know, it's, uh, the,

the GFC what was, again, it was

590

: 00:37:52

a, it was a challenging period

in the history of portable alpha.

591

: 00:37:56

and a lot of it was caused

by bad implementation.

592

: 00:38:00

You know, the alpha was correlated

with beta as a market regime shifted.

593

: 00:38:04

And so there was a lot of left tail

equity beta built into the alpha engine.

594

: 00:38:09

Uh, the alpha structures were too

illiquid and, or they got gated and

595

: 00:38:13

locked up exactly the wrong time.

596

: 00:38:16

And then we find examples of

ineffective collateral management

597

: 00:38:19

around the derivative beta book.

598

: 00:38:21

So if you have insufficient cash to fund

it, or you're, and then you're ultimately

599

: 00:38:26

forced to sell it at the trough, we

call that monetization of volatility.

600

: 00:38:30

And that's the last thing you

wanna do is sell at the bottom.

601

: 00:38:34

And so if you get the structuring right,

if you get the implementation right.

602

: 00:38:38

Execution, the risk management, it

can be a very effective tool, but you

603

: 00:38:42

have to get all those pieces kind of

in that system and framework approach.

604

: 00:38:45

You gotta piece those together.

605

: 00:38:49

Corey Hoffstein: Alright, so one of

the questions that comes up in every

606

: 00:38:51

single implementation call I have with

our clients is, how much should I do?

607

: 00:38:58

Okay, I, I really like this idea,

but how much should I stack on top

608

: 00:39:02

of my strategic asset allocation?

609

: 00:39:04

So I'm curious, what do the surveys say

about when an institution is adopting

610

: 00:39:09

this, how much capital are they putting

to work in this type of strategy?

611

: 00:39:13

Shane McCarthy: Yeah, it's a

very, very important question.

612

: 00:39:16

And again, it's very much dependent

on your overall profile, your overall

613

: 00:39:21

portfolio, and how you think about

your willingness and or ability to

614

: 00:39:25

take excess return over a benchmark.

615

: 00:39:28

Most everybody wants to enhance the

portfolio and they wanna do that

616

: 00:39:32

without disrupting index exposure.

617

: 00:39:34

I think sometimes a common mistake

can be that they're trying to

618

: 00:39:38

maximize alpha rather than thinking

about the interaction between alpha

619

: 00:39:43

and beta and how that outcome will

ultimately look on a realized basis.

620

: 00:39:48

There's not really a right or wrong here.

621

: 00:39:50

Again, it's just dependent on,

it's a design choice and it's

622

: 00:39:52

dependent on what you're looking for.

623

: 00:39:54

And again, it's functional.

624

: 00:39:55

If you're alpha sizing the volatility

of that alpha and the correlations

625

: 00:40:00

to the beta, most surveys show

that at least in the institutional

626

: 00:40:05

space, they're comfortable with

modest degrees of tracking error.

627

: 00:40:12

And so you can see here that you know,

per $100 of, of the alpha exposure per

628

: 00:40:19

$100 of beta, you find that over 50%

of 'em are allocating anywhere between

629

: 00:40:24

20-25 to 50 or zero to 50, in Alpha.

630

: 00:40:29

And so we find that pretty

consistently year over year.

631

: 00:40:33

Again, if the alpha's too large,

it can start to behave very

632

: 00:40:37

differently from the index.

633

: 00:40:39

And so we find a lot of of reasons

why people may or may not want that.

634

: 00:40:44

You know, in the institutional space

more the pensions and sovereign wealth

635

: 00:40:47

funds, we find it more of a moderate

overlay in that kind of 25 to 50.

636

: 00:40:52

It typically have, you know,

a strong governance structure.

637

: 00:40:56

They have board oversight, they have

consultant frameworks, and they have

638

: 00:41:00

a lower tolerance for tracking error.

639

: 00:41:02

And the private banks and the wealth

platforms, as we get more data around

640

: 00:41:06

that, we're also seeing more of a

moderate overlay, you know, client

641

: 00:41:10

stability considerations, model

portfolio constraints, you know,

642

: 00:41:15

even benchmark sensitivity seems

to be in that more moderate range.

643

: 00:41:19

Same thing with advisors and consultants.

644

: 00:41:22

And then as you expand the tracking

error, you know, you find that more

645

: 00:41:26

in endowments and, and foundations

and they just typically have

646

: 00:41:29

more flexibility than pensions.

647

: 00:41:31

They run diversified portfolios

and they're a little bit less rigid

648

: 00:41:35

on, on the benchmark constraints.

649

: 00:41:37

And then on the far end of the

spectrum where there's higher

650

: 00:41:40

tracking error, you see that more

in like family offices, right?

651

: 00:41:44

They can typically, they don't

have as much benchmark constraint.

652

: 00:41:48

They have longer time horizons and,

and you know, typically a simpler

653

: 00:41:52

governance structure as well.

654

: 00:41:53

And so there can be a range.

655

: 00:41:55

It's really just dependent on the channel.

656

: 00:41:58

Corey Hoffstein: If I can step in here,

Shane, really quickly just go back to

657

: 00:42:00

that slide because I think a lot of

people get caught off guard by this.

658

: 00:42:03

One of the examples I always like

to give is, you know, if you were

659

: 00:42:07

just doing long only active equity

managers, you can think about that as

660

: 00:42:13

an implicit portable alpha solution.

661

: 00:42:15

You're getting the benchmark

plus some sort of dollar neutral,

662

: 00:42:19

long short portfolio on top.

663

: 00:42:21

The stuff they're underweight

is your implicit shorts.

664

: 00:42:23

The stuff they're overweight relative to

the benchmark is their implicit longs.

665

: 00:42:28

And when you look at sort of the average

active equity manager, right, you probably

666

: 00:42:32

are getting an active share of about,

you know, 50%, which implies exposure of

667

: 00:42:37

$50 for every a hundred dollars of beta.

668

: 00:42:40

So a lot of people get caught off

guard with, wow, this seems like a lot.

669

: 00:42:43

And obviously the tracking error

component really matters as to a

670

: 00:42:47

hundred percent of low tracking error

is very different than, you know, a

671

: 00:42:49

hundred percent of high tracking error.

672

: 00:42:51

But this is not totally different

than what you see when you talk

673

: 00:42:55

about long only active managers.

674

: 00:42:57

The amount of active

exposure per unit of beta.

675

: 00:43:01

Shane McCarthy: Yeah, absolutely.

676

: 00:43:03

And again, it's just a

differentiated approach too to

677

: 00:43:05

generate that excess return.

678

: 00:43:07

So it's security selection and or

structuring excess return, approach.

679

: 00:43:12

And that's the beauty of it.

680

: 00:43:13

It can be very

complimentary to each other.

681

: 00:43:16

Corey Hoffstein: So I think you

have a slide next Shane, yeah.

682

: 00:43:18

That talks about the, the

actual tracking error.

683

: 00:43:20

I'd love to, I'd love you to dive

into this, the expectations around

684

: 00:43:24

what sort of tracking error they're

willing to take and the, and the

685

: 00:43:25

return that they're expecting for it.

686

: 00:43:28

Shane McCarthy: Yeah, I thought

this was a really good one.

687

: 00:43:30

again, it's about design

choice, customization.

688

: 00:43:33

I think investors are again, increasingly

comfortable with a, you know,

689

: 00:43:37

there some level of tracking error.

690

: 00:43:39

So on the left side there

you have this target portable

691

: 00:43:41

alpha tracking error survey.

692

: 00:43:44

And you know, you find that 40% of

the survey participants are in that

693

: 00:43:49

kind of zero to 4% of active risk

above and beyond the benchmark.

694

: 00:43:53

And then another 33% are in

that kind of four to 6% range.

695

: 00:43:58

There's a few that are in that six to

eight starting to get relatively high, and

696

: 00:44:02

then, you know, north of 8% on a tracking

error basis, it really starts to tail off.

697

: 00:44:09

On the right side, you see

the target alpha return for

698

: 00:44:13

the portable alpha strategies.

699

: 00:44:15

And there most of the survey participants

are in that kind of four to 8% range,

700

: 00:44:20

and then it falls off after that.

701

: 00:44:22

And that's, that's a good,

that's a good level to be at.

702

: 00:44:26

again, to exceed your financing costs

on the beta and to control how much

703

: 00:44:30

tracking error you want ultimately

in your portable Alpha program.

704

: 00:44:36

Corey Hoffstein: Shane, can you talk

a little bit about how people are

705

: 00:44:39

implementing Portable Alpha today?

706

: 00:44:40

We talked about how 2008, there was

sort of a structural mismatch in

707

: 00:44:44

how Portable Alpha was implemented.

708

: 00:44:45

There's been some innovations in

the way it's being delivered today.

709

: 00:44:48

Can you talk about what the survey

data says around what those approaches

710

: 00:44:52

are and how they're being adopted?

711

: 00:44:54

Shane McCarthy: Absolutely.

712

: 00:44:56

So there's three primary ways to

implement portable alpha, at least

713

: 00:45:01

we've ex, we've seen this in the

institutional industry and it really

714

: 00:45:04

ranges from simple to very complex.

715

: 00:45:08

And each of them come

with trade-offs, right?

716

: 00:45:10

Just like anything in life, simplicity,

control, costs, things like that.

717

: 00:45:14

And so that we find that the

sophisticated investors are more

718

: 00:45:18

geared toward direct implementation,

which is that third option there.

719

: 00:45:24

And that's where the institution will

have an alpha engine that they oversee

720

: 00:45:30

directly, and they've built the execution,

the technology, the infrastructure, the

721

: 00:45:36

risk management, the collateral management

around the beta component as well.

722

: 00:45:41

And they can manage the

whole system, if you will.

723

: 00:45:44

Like we talked about earlier.

724

: 00:45:46

On the opposite side would

be the one stop shop.

725

: 00:45:49

And we're seeing a plethora of

different products coming out right

726

: 00:45:53

now in the hedge fund space around

launching new funds and launching,

727

: 00:45:57

launching new share classes around that.

728

: 00:46:00

And so there it could be SMAs

feeder funds, share classes.

729

: 00:46:05

and, and again, you know,

like that construct, it's,

730

: 00:46:09

it's very capital efficient.

731

: 00:46:11

if you think about like a share class,

a dedicated portable alpha share class,

732

: 00:46:16

there can be some cross-contamination

risk because it's utilizing the

733

: 00:46:22

unencumbered cash inside the fund.

734

: 00:46:24

Where some of those investors who are

disinvested in another share class

735

: 00:46:27

for the Alpha engine only, some of

that gets used as part of the beta.

736

: 00:46:32

And so it constrains how much alpha

they can ultimately take in that

737

: 00:46:35

share class and the selection of

the beta for that share class.

738

: 00:46:40

And then in the middle there

is outsourcing to providers.

739

: 00:46:44

And we've seen this, this is something

that's been in the industry for

740

: 00:46:46

quite some time and that's where

the banks and or different solution

741

: 00:46:51

providers can execute the beta on

your, on behalf of the allocator.

742

: 00:46:56

And so that can be in swaps or futures,

they can manage the collateral around it.

743

: 00:47:01

And then the allocator has

their own hedge fund book.

744

: 00:47:04

It's a little bit more

fragmented, if you will.

745

: 00:47:08

and so it requires the allocator to

make sure to consolidate the whole

746

: 00:47:12

system together because they've

outsourced at least certain components

747

: 00:47:16

of the portable Alpha program.

748

: 00:47:19

Preferences around it.

749

: 00:47:20

This survey right here, you can see

that it is kind of split between one

750

: 00:47:24

stop shop and an allocator direct.

751

: 00:47:26

Again, the pensions are more in

the allocator direct and the one

752

: 00:47:29

stop shop is what we're seeing.

753

: 00:47:31

A, a lot of growth in that, from

a supply standpoint with, with

754

: 00:47:35

the, in the hedge fund community.

755

: 00:47:37

And really it just comes down to the

internal resources, your capability and

756

: 00:47:42

your governance structure around that

and what you're realistically able to do.

757

: 00:47:47

Morgan Stanley actually did put out a

recent report here in Q1 and they, they

758

: 00:47:52

unpacked the one stop shop even more.

759

: 00:47:55

And, you know, investors are

preferring the dedicated funds.

760

: 00:47:59

They, some of 'em want

SMAs with these managers.

761

: 00:48:02

Some of 'em go down the

the share class route.

762

: 00:48:05

But it's predominantly

more of a dedicated fund.

763

: 00:48:08

that it, it has the alpha engine,

has the beta component, they're

764

: 00:48:12

packaged together, and all the

execution and all the structuring

765

: 00:48:16

around it resides within the manager.

766

: 00:48:20

On a, a similar note, you know, uh, within

the one stop shop and the hedge fund

767

: 00:48:25

community, these, I thought this would

be interesting just to see what type of

768

: 00:48:31

terms we're, finding across the industry

as it relates to, you know, having, a

769

: 00:48:37

portable alpha program with a manager.

770

: 00:48:40

And so, you know, the manager

management fees there, there's

771

: 00:48:43

kind of a wide range there 50

basis points all the way up to 2%.

772

: 00:48:47

I think the performance fee, you

know, somewhere in that 15 to 20%,

773

: 00:48:51

but I would highlight it's alpha only.

774

: 00:48:53

we do find some research that shows

that most, majority of it is paid on

775

: 00:48:59

all periods for the alpha, but some,

there's only, you know, you're only

776

: 00:49:03

paid on outperformance in up periods.

777

: 00:49:06

And so there can be, there's a kind, kind

of different structuring around that.

778

: 00:49:11

the hurdle rate, it's effectively the

beta market, so you're only paying for the

779

: 00:49:16

scarce alpha and, and you're paying above

and beyond your be your beta benchmark.

780

: 00:49:22

On a liquidity terms you want to

keep it tight monthly to quarterly.

781

: 00:49:26

Again, you don't want anything

that's extremely illiquid in

782

: 00:49:30

there and lockups and all that.

783

: 00:49:31

So it's typically monthly or quarterly.

784

: 00:49:34

And then from a notice period

perspective, you also want to keep

785

: 00:49:37

that tight, and relatively short.

786

: 00:49:39

And so we find that mostly

in the 30 to 45 day period.

787

: 00:49:45

Corey Hoffstein: All right, Shane,

so we're coming towards the end here.

788

: 00:49:48

I wanna leave some time for

questions, but you know, if you

789

: 00:49:51

were to wrap this up and say sort.

790

: 00:49:53

What are the surveys saying about where

things are and where they're going?

791

: 00:49:58

Can you sort of maybe put a final bow

on this and, and, you know, as, as

792

: 00:50:02

these surveys have asked people about

their adoption, what are the trends

793

: 00:50:06

that we're seeing start to emerge?

794

: 00:50:08

Shane McCarthy: Yeah, I think the

overall strategic direction of the

795

: 00:50:12

industry is embracing it, not only

adoption, but conviction behind it.

796

: 00:50:17

And I think that's just been a lot

of understanding research around

797

: 00:50:22

it and, um, and just getting

allocators comfortable with it.

798

: 00:50:26

And they view it as a core portfolio tool.

799

: 00:50:29

you know, the, the edge is increasingly

how you implement it, and there's a,

800

: 00:50:34

there's a lot of different providers

out there and you know, whether it's

801

: 00:50:38

the beta component side of it or a

hedge fund doing it holistically.

802

: 00:50:42

And so it's not, it's, it is

really about how you implement it.

803

: 00:50:45

not necessarily just the

alpha that you select.

804

: 00:50:48

I think allocators honestly are

thinking about it more holistically,

805

: 00:50:53

and they want capital efficiency as a

core driver of excess return, allowing

806

: 00:50:58

their dollars to, you know, meet those

challenges in the liquid market portfolio.

807

: 00:51:02

I think that there's a

lot to be said about that.

808

: 00:51:06

and it's adoptions.

809

: 00:51:07

It's very, it's broadening, it's

across the investor landscape now.

810

: 00:51:11

We're seeing it in the wealth channels.

811

: 00:51:12

We're continuing to see increasing

demand in the institutional space.

812

: 00:51:16

And so I, I, I would imagine that

that would continue from here.

813

: 00:51:19

And it, again, if it's structured

correctly, it can enhance your

814

: 00:51:22

returns and diversify your liquid

market uh, traditional approaches.

815

: 00:51:28

Corey Hoffstein: Well,

thank you for that, Shane.

816

: 00:51:29

I gotta say this is the first time

I think I've done a webinar where

817

: 00:51:32

I have a number of questions that

are quite literal paragraphs.

818

: 00:51:35

So I think people are, are

excited to ask you some questions.

819

: 00:51:38

I think the survey data has, uh, has

caused people, you know, there's a

820

: 00:51:42

lot of interest in this and so I, I'm

gonna start working through these.

821

: 00:51:45

I'm gonna first say, we'll probably

gonna likely tip over the hour, so

822

: 00:51:48

to everyone who is joining and has

to sign off, thank you so much.

823

: 00:51:52

We are gonna try to get

through all these questions.

824

: 00:51:53

There's about five of them.

825

: 00:51:54

and if you have to sign off, don't worry.

826

: 00:51:56

There will be a replay and you

can, you can catch up to this.

827

: 00:51:59

So.

828

: 00:52:00

I'm gonna start with a question here,

Shane, I think really taps into the

829

: 00:52:03

customizable nature of portable alpha.

830

: 00:52:07

and, and this is a pretty niche

question, but it's when institutions

831

: 00:52:10

build a portable alpha program, how

should they decide what instrument

832

: 00:52:14

to use for the initial beta leave?

833

: 00:52:16

Listed futures, total return swaps,

or a fully funded ETF allocation?

834

: 00:52:21

How do the trade-offs compare on capital

efficiency financing, drag collateral

835

: 00:52:25

and liquidity management tracking error

governance burden, and the ability to

836

: 00:52:29

rebalance around alpha manager cash flows?

837

: 00:52:32

And based on the survey data, is

there anything that allocators

838

: 00:52:34

are actually landing on today?

839

: 00:52:36

Um, I have some some anecdotal

thoughts, but would love to hear

840

: 00:52:39

what you're seeing as, as you're

implementing this for clients.

841

: 00:52:43

Shane McCarthy: Do, do

you wanna start, Corey?

842

: 00:52:44

And I'll take it from there.

843

: 00:52:46

Corey Hoffstein: Yeah.

844

: 00:52:46

So I, I, I'll give a very quick

answer, which is, this is gonna

845

: 00:52:50

depend on a couple of things.

846

: 00:52:52

It's gonna depend on your liquidity needs.

847

: 00:52:55

Um, it's gonna depend on operations

and it's gonna depend on taxes.

848

: 00:52:59

So just as a very simple trade off, if

you are a taxable versus a non-taxable

849

: 00:53:05

entity, a non-taxable entity might

be able to use something like futures

850

: 00:53:09

very easily, where a taxable entity

might want to go for a long-term total

851

: 00:53:15

return bullet swap to try to capture

those long-term capital gains rather

852

: 00:53:21

than the 60 40 treatment of futures.

853

: 00:53:23

Now, that's a trade off of

credit risk with a bank.

854

: 00:53:26

Maybe some illiquidity depends

on is the access, accessibility

855

: 00:53:30

and all that sort of stuff.

856

: 00:53:31

So like taxable versus non-taxable

is going to be a big driver.

857

: 00:53:35

And then you're gonna have

financing drag, right?

858

: 00:53:38

So whether you're funding with, you know,

through futures or swaps or getting borrow

859

: 00:53:47

against your existing assets, box spreads.

860

: 00:53:50

You know, there's all sorts of ways

in which you can find financing, uh,

861

: 00:53:54

that all have different embedded rates.

862

: 00:53:57

There are firms that really

specialize in minimizing those rates.

863

: 00:54:00

But again, it's gonna come down to

the expertise and comfort of managing

864

: 00:54:04

all those different components.

865

: 00:54:05

So what I, what I would say I see in

practice is a lot of swaps, 'cause a

866

: 00:54:10

lot of the institutions that I talk

to are effectively, non-taxable.

867

: 00:54:16

And so therefore, you know, they can

just do a total return swap, not have to

868

: 00:54:19

deal with the bullet swap issue either.

869

: 00:54:21

They can just make it very easy one

and done with a bank, get the very

870

: 00:54:24

precise exposure, not have to deal

with, you know, weird financing

871

: 00:54:28

happening in the futures market.

872

: 00:54:29

They can lock in known financing

rates, which gives 'em some

873

: 00:54:32

certainty on the hurdle.

874

: 00:54:33

So there's a lot of attraction there.

875

: 00:54:36

I don't think I've seen anything in

the survey data Shane, that says what

876

: 00:54:39

institutions are adopting at large.

877

: 00:54:41

But, but curious as to what you're seeing.

878

: 00:54:44

Shane McCarthy: I haven't seen that

either at the instrument level,

879

: 00:54:46

uh, from a survey perspective.

880

: 00:54:48

but I would say, and I, I can talk

about how we, how we do it here.

881

: 00:54:52

We, we, you know, very much, you,

you listed out the instruments

882

: 00:54:55

that we think about as well, right?

883

: 00:54:56

Swaps, total return

swaps, futures, and ETFs.

884

: 00:55:02

We, we predominantly, for our core beta

allocation, we use total return swaps.

885

: 00:55:08

We think about it as that has

the lowest tracking error from

886

: 00:55:11

a beta component, to the index.

887

: 00:55:14

And so, and we think about it from

a tax efficiency standpoint as well.

888

: 00:55:18

So we also use bullet swaps.

889

: 00:55:20

We try to do it more than 12 months,

so we get the long-term capital

890

: 00:55:25

gains features built into that.

891

: 00:55:28

There are rebalancing components

to the vehicles that we run, and

892

: 00:55:32

so we trade futures, we trade

about 150, 160 markets as well.

893

: 00:55:38

So we can use that as a way to

rebalance in addition to maybe ETFs.

894

: 00:55:44

from a tax efficiency

standpoint, futures are great.

895

: 00:55:47

You get the 1256 tax treatment, uh, which

is a 60 40 long-term short-term cap gain.

896

: 00:55:53

And so we like the tax benefits of

both of them for different reasons.

897

: 00:55:58

I think from a a financing

perspective, we typically, you know,

898

: 00:56:04

like we, we put down anywhere up

to 20%, on the total beta exposure.

899

: 00:56:09

And so what you're doing there

relative to like futures is you're

900

: 00:56:13

putting down more upfront, but you're

having less variability on a mark to

901

: 00:56:18

market variation, margin perspective.

902

: 00:56:21

In futures, you know, let's take an S&P

500, you know, contract traded at the CME.

903

: 00:56:28

I think it's somewhere in that five

to 10% of initial margin to put down.

904

: 00:56:32

And then you have the mark to market

and you're doing that all the time.

905

: 00:56:36

It's fine.

906

: 00:56:37

You don't ha, it's not, it's very much

more cash efficient than swaps, let's say.

907

: 00:56:41

But you know, the banks, they

can raise margin requirements.

908

: 00:56:46

The exchanges can raise margin

requirements and that can be at

909

: 00:56:50

the, at the worst time when your

equity beta is in a drawdown.

910

: 00:56:54

So we like a little bit more

instability on margin with swaps.

911

: 00:56:58

We like the tax efficiency around that.

912

: 00:57:00

We use futures for rebalancing and

then we keep a cash reserve built into

913

: 00:57:05

our programs so that we, you know,

we think about it very much on what's

914

: 00:57:10

the frequency of rebalancing alpha and

beta, and what is our expected drawdown?

915

: 00:57:15

And so we look historically at that

beta benchmark that we're targeting.

916

: 00:57:19

We incorporate slippage into that.

917

: 00:57:22

And we're basically.

918

: 00:57:24

We're keeping a cash reserve around that.

919

: 00:57:26

And then, you know, within that waterfall

we're also to that divergent point.

920

: 00:57:31

We have a part of the portfolio that's

expected to pop at the right time

921

: 00:57:36

during that equity stress drawdown.

922

: 00:57:38

And so the whole waterfall

is uniquely designed.

923

: 00:57:41

and so, you know, it, it can really range.

924

: 00:57:44

It, it's just dependent on your

sophistication on what you want to trade.

925

: 00:57:47

futures are very easy.

926

: 00:57:49

Anybody can set up a FCM account

very, you know, seamlessly, swaps.

927

: 00:57:54

You happen to, you know,

they're more over the counter.

928

: 00:57:56

So you have to go with

is to counterparties and,

929

: 00:57:59

there's traded differently.

930

: 00:58:01

But you, it does allow a little

bit more customization in the

931

: 00:58:03

swap, uh, market versus futures.

932

: 00:58:07

And so there's this a range of different

factors that an allocator should

933

: 00:58:10

consider as it relates to the choosing

of how to implement a beta component.

934

: 00:58:16

Corey Hoffstein: You started to talk

a little bit about stress testing in

935

: 00:58:20

your waterfall setup there, Shane.

936

: 00:58:22

And that kind of leads into the

next question here, which is that

937

: 00:58:25

leveraged strategies can introduce

systemic risk if broadly adopted.

938

: 00:58:30

Do you think the usage of portable

alpha, if broadly adopted,

939

: 00:58:33

could pose systemic risks?

940

: 00:58:35

If so, what macro prudential frameworks

or aggregate metrics would you rely

941

: 00:58:38

on to monitor the compounding threats

of synthetic leverage, basis risk, and

942

: 00:58:43

structural illiquidity across the system?

943

: 00:58:46

Essentially is there any way to

know if it would be prudent to scale

944

: 00:58:49

back on portable alpha based on

how broadly utilized it has become?

945

: 00:58:55

Shane McCarthy: Yeah, I, I don't view it

as a systematic risk to, to the industry.

946

: 00:59:00

you know, I, I lived

through the credit crisis.

947

: 00:59:03

I saw, you know, the

mortgage backed market.

948

: 00:59:06

I saw collateralized

debt obligations to CDOs.

949

: 00:59:09

I saw CDS.

950

: 00:59:11

And there was a lot of

interrelationships during that time.

951

: 00:59:15

There's CDO squares.

952

: 00:59:16

There's a lot of just overlap.

953

: 00:59:18

here I, I, I don't see it that way.

954

: 00:59:20

Like the leverage built in is basically

to get the long only equity bait exposure

955

: 00:59:27

and it, it's more of a structuring thing

so that that unencumbered cash can go.

956

: 00:59:31

And again, as long as you design

the alpha engine the right way, you

957

: 00:59:35

methodically go through all the waterfall

tiers of your portable alpha program

958

: 00:59:39

and you stress test it the right way.

959

: 00:59:42

Again, it, it, it can be a

robust structure if you risk

960

: 00:59:45

manage it the right way.

961

: 00:59:47

You know, candidly, you can

even, you know, if you're in an

962

: 00:59:50

equity beta drawdown, let's say.

963

: 00:59:52

you, you can actually even relax,

relax some of the assumptions around

964

: 00:59:56

the beta one profile if you want.

965

: 00:59:58

Now you don't want to take it too

far 'cause then you're effectively

966

: 01:00:01

taking down the beta target at the

time that you're in a trough and

967

: 01:00:05

it's hard to climb back out of.

968

: 01:00:07

But we find that most of these

allocators, at least historically and

969

: 01:00:11

in the institutional space, they're,

you know, they have plenty of funding.

970

: 01:00:16

they can have backstop mechanisms

that are built into the

971

: 01:00:18

port portable alpha program.

972

: 01:00:21

They reserve a lot of cash.

973

: 01:00:23

They have a very targeted tracking error.

974

: 01:00:25

And to the point that I made

earlier, they're not trying

975

: 01:00:28

to maximize alpha necessarily.

976

: 01:00:30

They're trying to do it in

a very thoughtful way, but

977

: 01:00:33

in a risk controlled way.

978

: 01:00:35

And so if you're very careful around

it and you're careful around the

979

: 01:00:38

implementation and structuring, then

even if you get into certain issues,

980

: 01:00:43

it's very idiosyncratic to that investor.

981

: 01:00:45

It's not a complete unwind,

uh, of the whole industry.

982

: 01:00:49

Corey Hoffstein: Yeah, I'll add that,

you know, portable alpha as a, as a

983

: 01:00:52

construction concept, it's a very, you

know, template concept, but the way you

984

: 01:00:56

actually implement it, as we've addressed

in this webinar, is highly customized.

985

: 01:01:00

And so you might see some of these,

crowding effects show up in different

986

: 01:01:05

ways in the different alpha strategies.

987

: 01:01:06

Obviously you'd see the

alpha disappear, right?

988

: 01:01:10

That's, but you know, when there's

volatility, that might take a couple

989

: 01:01:13

years to figure out whether the

alpha's truly disappeared, disappeared.

990

: 01:01:16

In the beta side, if too many people are

asking for leverage, ultimately that's

991

: 01:01:21

going to be a cost that's gonna show up

in the funding spreads, which is going

992

: 01:01:26

to increase the hurdle rate of the alpha.

993

: 01:01:29

So as portable alpha de, you know,

there's increasing demand for it, unless

994

: 01:01:35

there's increasing balance sheet support

from counterparties who are willing

995

: 01:01:38

to be on the other side of the beta

trade to, to make it capital efficient.

996

: 01:01:42

Um, that financing rate will

go up and up and up and then

997

: 01:01:44

ultimately make it unattractive.

998

: 01:01:46

So there are some natural market

mechanisms that balance this out.

999

: 01:01:51

but I think we're, we're very far

away from that from a true, you

: 1000

01:01:54,461 --> 01:01:56,321

know, can this create systemic risks?

: 1001

01:01:56,321 --> 01:01:59,201

Again, it, as long as there's

diversification across what people are

: 1002

01:01:59,201 --> 01:02:03,431

using the alpha for and people are being

prudent about how they're building in

: 1003

01:02:03,431 --> 01:02:08,031

buffers and margin and liquidity for the

beta, and they're not matching totally

: 1004

01:02:08,031 --> 01:02:14,061

illiquid things, there, in my opinion,

isn't a huge amount of, of systemic

: 1005

01:02:14,061 --> 01:02:16,071

risk that that can actually happen here.

: 1006

01:02:16,071 --> 01:02:18,531

There's so much diversification

in implementation.

: 1007

01:02:18,981 --> 01:02:19,911

Um, you don't really,

: 1008

01:02:20,001 --> 01:02:20,511

Shane McCarthy: I agree,

: 1009

01:02:20,511 --> 01:02:21,351

Corey Hoffstein: get that effect.

: 1010

01:02:21,471 --> 01:02:26,271

Shane McCarthy: You design the Alpha

engine the right way and you manage

: 1011

01:02:26,271 --> 01:02:30,141

the collateral side of it and the

waterfall around the beta side.

: 1012

01:02:30,501 --> 01:02:34,431

Again, the leverage that's embedded in

portable alpha is to give you that long

: 1013

01:02:34,431 --> 01:02:36,741

only beta exposure, very cash efficiently.

: 1014

01:02:37,101 --> 01:02:42,051

It enables the structure and,

arguably it's enabling the

: 1015

01:02:42,051 --> 01:02:43,881

separation of alpha and beta.

: 1016

01:02:43,881 --> 01:02:48,531

So if you design a, a really sound

alpha engine, it separates that, that

: 1017

01:02:48,531 --> 01:02:52,341

leverage allows you to allocate to

that and separate that out and isolate

: 1018

01:02:52,341 --> 01:02:54,591

the properties between beta and alpha.

: 1019

01:02:55,011 --> 01:02:57,291

And it, it, it's, it's a

better overall portfolio.

: 1020

01:02:57,546 --> 01:03:01,851

You, you can see too that, you know,

even relative to a benchmark, you

: 1021

01:03:01,851 --> 01:03:06,591

can design an alpha engine to reduce

the risk relative to that index.

: 1022

01:03:06,801 --> 01:03:10,911

So you can take down drawdowns, you

can take down the volatility of the

: 1023

01:03:10,911 --> 01:03:16,971

overall program, again, relative to

the index, but that, that reflects

: 1024

01:03:16,971 --> 01:03:21,441

incorporating different things like a

convergent and a protective, divergent

: 1025

01:03:21,441 --> 01:03:24,831

type of property and blending those

two together in thoughtful ways

: 1026

01:03:25,701 --> 01:03:27,921

Corey Hoffstein: Every time I think we're,

we're getting through the question, Shane.

: 1027

01:03:27,921 --> 01:03:30,021

I keep getting more added, so, you know.

: 1028

01:03:30,201 --> 01:03:33,081

We'll, well I guess we'll stay here as

long as the questions keep coming in.

: 1029

01:03:33,441 --> 01:03:35,781

Someone wrote in, uh, two

quick questions for you.

: 1030

01:03:35,811 --> 01:03:38,541

Understanding that liquidity

is a core tenet of your

: 1031

01:03:38,541 --> 01:03:40,841

approach, given the L in lab.

: 1032

01:03:41,111 --> 01:03:44,231

Can you speak to the underlying

liquidity profile of the

: 1033

01:03:44,231 --> 01:03:46,181

alpha piece of your solutions?

: 1034

01:03:46,181 --> 01:03:50,351

What is your tolerance for illiquidity

within the alpha component?

: 1035

01:03:50,471 --> 01:03:54,461

In other words, what's the worst

liquidity profile you'll entertain

: 1036

01:03:54,461 --> 01:03:59,031

in the allocations you talk about

making, part of your alpha engine?

: 1037

01:03:59,721 --> 01:04:01,791

And the second question is related

to fees, but maybe we can, we

: 1038

01:04:01,791 --> 01:04:05,151

can touch on this first, this,

this, you know, how illiquid will

: 1039

01:04:05,151 --> 01:04:06,651

you get in the pursuit of alpha?

: 1040

01:04:07,671 --> 01:04:11,511

Shane McCarthy: We think

about it in 90 days or less.

: 1041

01:04:11,541 --> 01:04:15,921

And that's because the strategies

that we run, it allows for us to

: 1042

01:04:15,921 --> 01:04:19,971

rebalance the alpha and the beta

component on a quarterly basis.

: 1043

01:04:20,151 --> 01:04:21,411

And so we, we do that.

: 1044

01:04:21,831 --> 01:04:25,731

And so we think about the modeling

of the beta and rolling three

: 1045

01:04:25,731 --> 01:04:29,961

month intervals, calendar quarters,

we go back decades and decades.

: 1046

01:04:30,231 --> 01:04:31,761

And again, we try to stress that.

: 1047

01:04:32,781 --> 01:04:37,941

That rebalancing policy between beta and

alpha, it's, typically about a quarter.

: 1048

01:04:38,481 --> 01:04:42,421

We do, we're very thoughtful

around the alpha, components

: 1049

01:04:42,421 --> 01:04:43,891

that are built into the engine.

: 1050

01:04:44,281 --> 01:04:49,111

And so we trade a lot of exchange

traded features already on our platform

: 1051

01:04:49,321 --> 01:04:51,151

with our systematic strategies.

: 1052

01:04:51,481 --> 01:04:55,681

And then we structure a lot of these

other strategies to be very thoughtful

: 1053

01:04:55,681 --> 01:04:59,941

around being able to liquidate very

quickly the cross margin with our

: 1054

01:04:59,941 --> 01:05:02,251

other components in the alpha engine.

: 1055

01:05:02,581 --> 01:05:06,121

And again, we wanna keep it at 90

days or less so that we can rebalance

: 1056

01:05:06,121 --> 01:05:07,591

the alpha and beta very thoughtfully.

: 1057

01:05:09,192 --> 01:05:11,862

Corey Hoffstein: The second question was,

was about fees, which that question came

: 1058

01:05:11,862 --> 01:05:15,762

in before we, we got to the fee slide,

so hopefully the fee slide addressed it.

: 1059

01:05:16,162 --> 01:05:20,152

question here, and this is actually

reminiscent to me of the new sort of

: 1060

01:05:20,182 --> 01:05:25,702

emergence of the, the total portfolio

approach that is gaining traction taken

: 1061

01:05:25,702 --> 01:05:32,032

from Canadian pensions and, and being

adopted by US institutions where instead

: 1062

01:05:32,032 --> 01:05:35,392

of looking at things as separate asset

classes, you know, they're looking at

: 1063

01:05:35,422 --> 01:05:39,592

things in terms of more of a factor lens

and how they apply to the portfolio.

: 1064

01:05:39,592 --> 01:05:44,332

And so the question here is, does Shane

view convergent and divergent strategies

: 1065

01:05:44,332 --> 01:05:48,352

almost as their own asset classes, rather

than thinking about it as, say, equity

: 1066

01:05:48,352 --> 01:05:52,852

market neutral or relative value as

separate asset classes or strategies,

: 1067

01:05:53,002 --> 01:05:56,842

would you really just classify them

as a single convergent asset class?

: 1068

01:05:58,606 --> 01:06:03,076

Shane McCarthy: We, we focus on the

statistical properties of what convergent

: 1069

01:06:03,076 --> 01:06:07,186

offers relative to what divergent offers.

: 1070

01:06:07,186 --> 01:06:07,306

So.

: 1071

01:06:07,981 --> 01:06:10,651

I think asset class

would, would be a stretch.

: 1072

01:06:10,651 --> 01:06:15,936

We just, we think about it, it goes back

to this durability of an alpha engine.

: 1073

01:06:16,386 --> 01:06:21,006

We want a positive carry component

with, and it's a risk budgeting approach

: 1074

01:06:21,006 --> 01:06:25,416

where we want a certain percentage of

our portfolio risks to be allocated

: 1075

01:06:25,416 --> 01:06:29,196

to strategies that are designed

to make money in normal periods.

: 1076

01:06:29,616 --> 01:06:33,546

And, and then the remainder of the

risk budget is to go into stuff

: 1077

01:06:33,546 --> 01:06:35,106

that are more protective in nature.

: 1078

01:06:35,466 --> 01:06:38,976

And so we think about it as a

portfolio construction framework.

: 1079

01:06:39,396 --> 01:06:41,226

Rather than an asset class.

: 1080

01:06:41,686 --> 01:06:46,301

and, and so we, we take these properties

and, and as we underwrite them and

: 1081

01:06:46,301 --> 01:06:50,051

we include them in our alpha engine,

we're very much focused on that.

: 1082

01:06:50,261 --> 01:06:51,671

Is something additive?

: 1083

01:06:51,941 --> 01:06:56,861

Does it fit in one of those buckets

and is it meeting our expectations

: 1084

01:06:56,861 --> 01:07:01,361

on what that type of property is and

what it can deliver as it relates to

: 1085

01:07:01,361 --> 01:07:06,371

the alpha engine in isolation or in

the broader portable alpha construct?

: 1086

01:07:07,811 --> 01:07:08,021

Corey Hoffstein: All right.

: 1087

01:07:08,021 --> 01:07:12,221

Two questions left here, Shane, unless

someone answer asks a surprising new one.

: 1088

01:07:12,701 --> 01:07:17,681

given that portable alpha is seeing a

reemergence, are we seeing that the people

: 1089

01:07:17,711 --> 01:07:23,471

offering portable alpha solutions are

primarily upstart firms or are we seeing

: 1090

01:07:23,471 --> 01:07:29,831

portable alpha solutions being offered

by sort of your premier hedge funds?

: 1091

01:07:30,461 --> 01:07:30,971

Shane McCarthy: Both.

: 1092

01:07:31,841 --> 01:07:34,961

There's a lot of Premier hedge

funds that are, are doing it.

: 1093

01:07:35,051 --> 01:07:39,116

Uh, they're launching new share

classes, to meet the demand that we're

: 1094

01:07:39,116 --> 01:07:40,616

seeing in the institutional space.

: 1095

01:07:41,166 --> 01:07:45,966

you know, we typically see a global

equity benchmark, like in ACWI or world

: 1096

01:07:45,966 --> 01:07:48,106

as, the choice for the beta component.

: 1097

01:07:48,796 --> 01:07:52,636

And then again, they use their own

alpha engine as the alpha side of it.

: 1098

01:07:53,776 --> 01:07:57,526

We believe in a multi-strategy approach

through this convergent, divergent

: 1099

01:07:57,886 --> 01:07:59,716

implementation approach on Alpha.

: 1100

01:08:00,226 --> 01:08:03,526

some of these designs that you're

seeing with these, whether it's

: 1101

01:08:03,526 --> 01:08:06,826

premier or startup hedge funds,

it can be a single alpha source.

: 1102

01:08:07,276 --> 01:08:10,246

And again, if it's convergent

in nature, you're getting that

: 1103

01:08:10,246 --> 01:08:12,826

exposure under normal periods.

: 1104

01:08:13,936 --> 01:08:16,276

You're losing out though on some

of the protective features that are

: 1105

01:08:16,276 --> 01:08:18,046

built in with a divergent property.

: 1106

01:08:18,406 --> 01:08:23,116

And so, you know, you, you can go

into it, it's a seamless transaction,

: 1107

01:08:23,426 --> 01:08:25,256

to a share class from a hedge fund.

: 1108

01:08:25,645 --> 01:08:27,895

And again, there's sort of

cross contamination risk,

: 1109

01:08:27,895 --> 01:08:29,156

like I mentioned earlier.

: 1110

01:08:29,501 --> 01:08:30,401

But it's seamless.

: 1111

01:08:30,401 --> 01:08:35,291

And then you package all the operational

complex complexities inside the manager

: 1112

01:08:35,321 --> 01:08:37,121

and allow them to do all that for you.

: 1113

01:08:38,231 --> 01:08:38,441

Corey Hoffstein: All right.

: 1114

01:08:38,441 --> 01:08:39,581

Last question.

: 1115

01:08:39,640 --> 01:08:42,341

And it's a question going back

to the slide about alpha exposure

: 1116

01:08:42,341 --> 01:08:43,691

per a hundred dollars of beta.

: 1117

01:08:44,291 --> 01:08:48,731

And the question here is, how can the

portable alpha work if it's only on 25 or

: 1118

01:08:48,731 --> 01:08:52,241

50 cents, uh, of alpha per unit of nav?

: 1119

01:08:52,781 --> 01:08:56,140

Is there enough idio risk to

exceed the cost of financing

: 1120

01:08:56,140 --> 01:08:57,191

that a hundred dollars of beta?

: 1121

01:08:57,191 --> 01:09:02,441

Or do those alpha percents really only

apply for very volatile CTA strategies?

: 1122

01:09:02,441 --> 01:09:06,390

And I think this, this is a really, it's

a nuanced question, but it ties into the

: 1123

01:09:06,390 --> 01:09:12,451

idea of, you know, a a dollar of alpha is

not the same across strategies that have

: 1124

01:09:12,451 --> 01:09:14,881

very different, uh, levels of idio risk.

: 1125

01:09:15,571 --> 01:09:15,961

Shane McCarthy: Yep.

: 1126

01:09:16,921 --> 01:09:18,631

So, yeah, it's a really good question.

: 1127

01:09:18,691 --> 01:09:22,560

and it's very dependent on the

construction of the alpha engine,

: 1128

01:09:22,651 --> 01:09:26,791

what type of, uh, volatility you're

running at within the Alpha Engine.

: 1129

01:09:26,911 --> 01:09:30,241

and ultimately what, you know, what,

what are the financing costs embedded

: 1130

01:09:30,241 --> 01:09:31,560

in the portable Alpha program?

: 1131

01:09:31,951 --> 01:09:33,661

And that is definitely not stable.

: 1132

01:09:34,060 --> 01:09:38,736

you, you know, we talked about swaps

in futures, in swaps, you know, it's

: 1133

01:09:38,736 --> 01:09:40,145

a secured overnight funding rate.

: 1134

01:09:40,326 --> 01:09:42,725

d so that's been around since: 2018

: 1135

01:09:42,996 --> 01:09:46,626

You find that as a financing rate, more

or less, it kind of tracks fed funds.

: 1136

01:09:47,166 --> 01:09:50,946

Uh, in the early days from

inception in: 2018

: 1137

01:09:50,946 --> 01:09:52,716

of in that one to 2% range.

: 1138

01:09:53,196 --> 01:09:58,656

It declined, uh, through the COVID period,

basically flat, you know, maybe 50 bips.

: 1139

01:09:59,226 --> 01:10:05,106

And then with the inflation spike and

fed hiking rates through 22 and 23, you

: 1140

01:10:05,106 --> 01:10:09,546

saw that SOFR rate and you pay a spread

over that, to be clear too, to the banks.

: 1141

01:10:09,936 --> 01:10:14,016

So, but the base, SOFR rate

went up, you know, near 5%.

: 1142

01:10:14,586 --> 01:10:18,126

Now, some of these divergent

and convergent strategies can

: 1143

01:10:18,126 --> 01:10:19,686

be impacted in different ways.

: 1144

01:10:20,331 --> 01:10:24,021

On the divergent side, they're

very cash efficient, right?

: 1145

01:10:24,021 --> 01:10:28,461

So they sit on a lot of unencumbered cash

and setting aside the alpha component

: 1146

01:10:28,461 --> 01:10:32,781

of it, their base return can go up

because they're sitting on that cash.

: 1147

01:10:33,231 --> 01:10:36,441

Or maybe in trend following, they

can trade the directionality of

: 1148

01:10:36,441 --> 01:10:40,371

the short term rate market and make

some money in that uh, on that side

: 1149

01:10:40,371 --> 01:10:44,991

of stuff, on the convergence side,

they're lower capacity, they're

: 1150

01:10:44,991 --> 01:10:46,821

more highly levered type of trades.

: 1151

01:10:47,001 --> 01:10:49,251

So there's a financing

cost embedded in there.

: 1152

01:10:49,701 --> 01:10:54,591

It can cause more dispersion if we see

rate volatility, which can be good for

: 1153

01:10:54,591 --> 01:10:58,791

convergence strategies, but the financing

rates could be an offset to that if

: 1154

01:10:58,791 --> 01:11:01,191

you see elevated, uh, rates in there.

: 1155

01:11:01,461 --> 01:11:04,431

So it's very, very much

dependent on the SOFR rate.

: 1156

01:11:04,791 --> 01:11:08,116

and, and then also, you know, again,

how you design your alpha engine

: 1157

01:11:08,536 --> 01:11:11,776

and sometimes that 25% or less.

: 1158

01:11:12,176 --> 01:11:16,891

It, it may not always, give you that

excess return positive tracking error.

: 1159

01:11:17,251 --> 01:11:19,621

And so you have to have a

willingness to take that and there

: 1160

01:11:19,621 --> 01:11:21,001

can be variability around that.

: 1161

01:11:21,751 --> 01:11:24,031

Corey Hoffstein: The other subtle

nuance I'll add here is, is there's

: 1162

01:11:24,031 --> 01:11:27,661

a very big difference if a hundred

percent of your beta is being

: 1163

01:11:27,661 --> 01:11:31,291

achieved synthetically versus a mix

of synthetic and cash exposure, right?

: 1164

01:11:31,291 --> 01:11:36,601

If you're only adding an overlay of $25

of alpha for a hundred of beta, you might

: 1165

01:11:36,601 --> 01:11:43,561

be able to put 50 to $60 of that beta in

cash beta exposure, and then you're not

: 1166

01:11:43,561 --> 01:11:48,541

incurring a borrow rate or a financing

rate, which makes the hurdle rate, you

: 1167

01:11:48,541 --> 01:11:51,061

know, much lower for the total portfolio.

: 1168

01:11:51,361 --> 01:11:55,681

So there are a lot of implementation

nuances here and that's why it's

: 1169

01:11:55,681 --> 01:11:57,991

worth talking, talking to the

experts about how they're doing it.

: 1170

01:11:58,021 --> 01:12:00,511

So, well, we finally made it

through all the questions.

: 1171

01:12:00,511 --> 01:12:02,971

I appreciate everyone who stuck

around for an extra, 15 minutes.

: 1172

01:12:02,971 --> 01:12:05,161

It was the vast majority of you.

: 1173

01:12:05,191 --> 01:12:06,991

So I hope that that was useful.

: 1174

01:12:06,991 --> 01:12:08,821

Really appreciate the detailed question.

: 1175

01:12:08,821 --> 01:12:10,756

Shane, this has been phenomenal.

: 1176

01:12:10,756 --> 01:12:13,186

I appreciate you walking us

through what all the new survey

: 1177

01:12:13,186 --> 01:12:14,866

data says about the adoption.

: 1178

01:12:15,016 --> 01:12:18,436

If folks wanna learn more

about LABQs and and what you're

: 1179

01:12:18,436 --> 01:12:19,876

doing, where can they find you?

: 1180

01:12:21,136 --> 01:12:21,626

Shane McCarthy: Yeah, at LAB-Qs.com.

: 1181

01:12:23,266 --> 01:12:27,526

And, you know, I would add

into that we are about a month

: 1182

01:12:27,526 --> 01:12:32,026

or two out from developing an

educationally focused website.

: 1183

01:12:32,056 --> 01:12:33,436

It's portable alpha.com.

: 1184

01:12:33,436 --> 01:12:35,146

Can't get it any easier than that.

: 1185

01:12:35,626 --> 01:12:38,446

And we're, uh, you know,

nearing completion on that.

: 1186

01:12:38,896 --> 01:12:42,346

And so I'd encourage everybody to, you

know, when it's up and running to go

: 1187

01:12:42,346 --> 01:12:46,786

out there and we're gonna put, you know,

a lot of, uh, education around what

: 1188

01:12:46,786 --> 01:12:48,436

this means and how to think about it.

: 1189

01:12:48,436 --> 01:12:51,886

And we're gonna continue to kinda

focus in this area and, and try to,

: 1190

01:12:52,166 --> 01:12:53,906

promote the technique as much as we can.

: 1191

01:12:53,906 --> 01:12:55,676

So I'd encourage you to go look at that.

: 1192

01:12:56,591 --> 01:12:59,891

Corey Hoffstein: And for folks tuning in

who are looking to implement this in the

: 1193

01:12:59,891 --> 01:13:03,791

wealth space, I'll remind you we have

tons of resources at returnstackedetfs.com

: 1194

01:13:04,785 --> 01:13:07,695

So if you're looking to learn more

about how those can work and how

: 1195

01:13:07,695 --> 01:13:10,215

those can be applied in the portfolios

you're developing for clients,

: 1196

01:13:10,545 --> 01:13:11,975

please go to returnstacked.com

: 1197

01:13:12,105 --> 01:13:13,905

and get in touch with

one of our consultants.

: 1198

01:13:14,415 --> 01:13:16,395

Alright, everyone, thank

you for your time today.

: 1199

01:13:16,395 --> 01:13:17,415

Really appreciate it.

: 1200

01:13:17,415 --> 01:13:18,885

Have a wonderful rest of your day.

: 1201

01:13:20,145 --> 01:13:20,695

Shane McCarthy: Thanks Corey.

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