Alpha transfer: Optimising the benefit of active management

This paper shows that it is possible to separate investment policy, the benchmark asset class or asset classes an investor wishes to invest in, from the ‘investment management structure or how the assets are divided amongst investment managers’ and the asset classes in which investment is actually made. This paper begins by showing that active management appears to work in some markets and not to work in others. Once this is established, the paper shows how an asset manager or client will be better off investing investment managers with expertise in those asset classes where active management works and then transferring it to those asset classes to which exposure is desired. The paper will construct an ‘alpha efficient frontier’ that allows an investor to choose among feasible ‘optimal’ expected alpha and tracking error combinations. In this way, the investor creates the ‘optimal’ investment structure. It will do an analysis of the performance of certain selected combinations of this efficient frontier. The paper shows how, using derivatives, the desired investment policy can be achieved independently of the optimal investment structure.