The idea that there is a reward in bearing uncertainty – that gains are proportional to risks – is not only intuitive but a deeply-rooted assumption in the investment culture. Its explanation, however, has required a decades-long challenge to understand the drivers of investment returns. On top of this, the debate over active and passive investment – between Alpha and Beta – has unveiled that, instead of pure skill, a great portion of the excess return over a benchmark results from the exposure to a set of industry or firm-specific characteristics of financial securities, the so-called investment factors. Eventually, starting from the famous equity risk premium, many other risk premia have emerged during the years, paving the way to the modern factor-based approach to portfolio management. Nevertheless, excess returns are not going to disappear anytime soon. As we are going to see, what is changing is the dimension in which they exist, as they move from being strategy-specific to being allocation-driven.

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This leaves us with a thought-provoking question: is Alpha transforming into the ability to move between Betas?

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Introduction

As investing involves risk, managing its exposure and picking the right securities are an investment manager’s first concerns when it comes to building a portfolio. Indeed, an efficient allocation of capital is not just a matter of performance, but a complex set of decisions that requires returns to be constantly benchmarked against the amount of risk taken.