In this use case, we will present a framework by which we can estimate the nature of the alpha generated by an active manager. This quantitative multi-asset approach projects the risk of the fund onto market-weighted benchmarks and orthogonal style factors. By doing so, it enables investors to differentiate the risk budget allocation of a manager to alpha rather than from factor or market exposures. Such differentiation achieves two fundamental objectives for an asset allocator:
- From a risk perspective, investors need to control their exposure to market beta, aka systematic market risk, and factors to avoid concentration risks in their portfolio.
- From an efficiency perspective, the cost of alpha-seeking funds should be carefully quantified and monitored in excess of the desired benchmark and factor exposures.
By construction, this alpha is independent from the broad market factors and is referred to as “true alpha” in some literature. Alpha can be generated from the specific security selection or market timing of factors.