Foreword by William Gross



Chapter 1: Overview of Book and Key Concepts

Borrowing to Achieve Higher Returns

Leverage—The Good, The Bad, and The Ugly

The Confusion Surrounding Alpha and Beta

Portable Alpha Definitions and Trends

Back to The Basics: Investments 101

Asset Allocation and Portable Alpha

Alpha, Beta, and Alpha-Beta Separation

Global Sources of Portable Alpha, Associated Risks, and Active Management

Derivatives-Based Beta Management

Portable Alpha Implementation

The Real Holy Grail: Risk Measurement and Management

Liability-Driven Investing

Portable Alpha Theory and Practice: Wrapping It Up

Chapter 2: Portable Alpha Definitions and Trends

The Value of and Components to Porting Alpha

The Derivatives-Based Market Exposure (BETA)

The Alpha Strategy

Common Misperceptions

The Evolution of Portable Alpha

A New Paradigm?

The Importance of Return—and Risk


Chapter 3: Back to the Basics: Investments 101

The Optimal Investment Portfolio

Utility Functions and Risk Aversion

Portfolio Selection and The Efficient Frontier

The Capital Market Line

Capm and Factor Models

The Benefits of Diversification

Risk Premiums

Theory Versus Reality


Appendix 3.1 Option Pricing

Appendix 3.2 Merger Arbitrage Example

Chapter 4: Asset Allocation and Portable Alpha

A World of Lower Returns

The Classic Model for Portfolio Construction

Challenges With The Classic Model

Portable Alpha, Level One

Portable Alpha, Level Two

Pitfalls of Porting

Risk Budgeting: An Imprecise Science

Sustainable Spending In A Lower-Return World

The Constituent Parts of A Spending Policy

The Risk Premium and The Building Blocks of Return

The Role of Alpha in Setting Expectations


The Implications of A Slender Risk Premium

Stocks For The Long Run?

Dividends and A Slender Risk Premium

Benchmarking At The Portfolio Level

In Search of A Better Risk Measure

What is Success?


Chapter 5: Alpha, Beta, and Alpha-Beta Separation

Beta and Alpha Defined

Capm, Alpha, and Beta

Alpha and Beta in A Portfolio Evaluation Context

The Relevance of Alpha Versus Excess Return

Key Challenges of Alpha-Beta Separation and Estimation

Alpha is Not Alpha Without Beta

Porting Can Be Costly

Is The Alpha Actually Alpha?

Beta + Beta (+ Beta . . .) + Alpha?


Appendix 5.1 The Trouble with Alpha By Jamil Baz

Chapter 6: Global Sources of Portable Alpha, Associated Risks, and Active Management

Overview By Sabrina Callin and Alfred Murata

The Equity Markets By Don Suskind

The Fixed-Income Markets By Steve Jones

Global Diversification and Currency By Richard Clarida

Hedge Funds Strategies By Lisa Kim


Chapter 7: Derivatives-Based Beta Management

Securities Lending As A Form of Low-Risk Portable Alpha



Beta Management: Basis Risk

Examples of Proactive Beta Management

Beta Management: Operational Risk



Chapter 8: Portable Alpha Implementation

The Alpha Strategy

The Derivatives-Based Market Exposure (BETA)

Liquidity For Margin Or Collateral Calls

Consolidated Risk Management, Monitoring, and Reporting

Integrated Approaches

Segregated Approaches

Semibundled Approaches

Comparing and Contrasting Different Approaches

Implementation Costs

Evaluating Portable Alpha Implementation Approaches


Appendix 8.1 Segregated Portable Alpha Case Study By Bruce Brittain

Chapter 9: The Real Holy Grail: Risk Measurement and Management

Identifying Risks: Alpha, Beta, and Leverage

Liquidity and correlation

The Consequences of Leverage

Stress Testing: Measuring Risk in Portable Alpha

History and Time Horizons


Chapter 10: Liability-Driven Investing

What is LDI?

Less Room for Complacency

Examining The Liabilities

Liability-Driven Investing

Case Study: Into Phase III

Beyond Ldi: Incorporating Factors Outside The Pension Plan


Appendix 10.1 Building Better Betas Through Financial Engineering

Chapter 11: Portable Alpha Theory and Practice: Wrapping It Up

Ability To Borrow Through The Derivatives Market Sets The Stage For Portable Alpha

Central Underpinnings To Modern Portfolio Theory Are Highly Relevant

Alpha And Beta—it’s The Combination That Matters

A Wide Variety of Alpha Sources Are Available

The Key is Identification, Measurement, and Diversification of Risk Factors

It’s Important Not To Lose Sight of The Policy Portfolio

Prudent Derivatives-Based Beta Management is Not Free

Portable Alpha Implementation Can Be Complex and Costly

Risk Management is A Critical Component of Success

Portable Alpha is Also Valuable for Investors Focused On LDI

Portable Alpha Provides Tools For Better Investment Results

Epilogue: Portable Alpha—The Final Chapter: Schemes, Dreams, and Financial Imbalances: “There Must Be More Money”

Risk Asymmetries: Volatility, Spread, Leverage

Absolute Return Dynamics

The U.S. Current Account Deficit, War, and Hedge Funds: Briefly

Public Policy Implications



About the Authors




Sometimes you work for so long, or at the same company for so many years, that you lose perspective on what has been accomplished. I can remember the early years of financial innovation very well, but sometimes an outsider’s comments are necessary to highlight what really has taken place. PIMCO’s innovative and early move into portable alpha strategies was to me and my early associate Chris Dialynas a logical extension of an evolving active-management strategy that featured futures and the cash backing behind them. Not only were Treasury futures extremely cheap, but we felt that the cash backing our commitment could be invested at higher yields with little maturity extension or credit impairment. Soon thereafter the strategy was applied to pure stock index portfolios under the name of StocksPLUS. The fact that there was a portable alpha component to it never really occurred to us; or I should say the term portable alpha never really occurred to us. Nonetheless, the results were remarkable.

It was only later, when the academic literature began to recognize the ability of higher-return investments to enhance futures and index-related products, and the strategy of combining various asset classes into a higher-returning recipe, that the term portable alpha crossed our desks and became part of PIMCO’s conventional wisdom. And it was only recently, when Peter Bernstein acknowledged in his latest book, Capital Ideas Evolving, that PIMCO had been the first to actively employ portable alpha strategies, that we looked back on what we had done from an outsider’s perspective. Pretty cool, we all thought, to have been part of financial history without really knowing it!

I suppose it shouldn’t have been such a surprise. PIMCO professionals have had a storied history of innovation for decades now. The following book—superbly orchestrated by Sabrina Callin and magnificently written by numerous PIMCO professionals—is a testament to that innovation and a further step down the road to bring an understanding of the concept to an investment public eager to learn how at least some of it is done. I congratulate this PIMCO team and urge you to absorb as much as you can, as well as to pursue follow-up inquiries with us personally. Our knowledge—in addition to our alpha—is portable. May it always be so.

William Gross


Portable alpha is one of the more talked-about topics in the asset management industry today. It is almost impossible to pick up a copy of an industry publication or a financial journal without finding some mention of the term portable alpha or related concepts. Many conferences have been dedicated to the topic, and some in the industry have even anointed portable alpha and alpha-beta separation as the holy grail of investing or a new paradigm in modern investment management. While portable alpha strategies have been around for over 20 years, the somewhat recent increase in investor risk appetites and comfort with the use of derivatives appears to have contributed to a proliferation of portable alpha strategies and related services. At the same time, significant growth in the derivatives markets has increased the number of potential applications for the portable alpha concept.

The idea that portable alpha strategies may provide a solution that enables investors to meet or exceed return targets is certainly appealing, as are the potentially powerful diversification benefits. In addition, for investors focused on liability-driven investing (LDI), portable alpha applications can offer compelling reductions in liability-relative risk. Of course, portable alpha strategies do not defy the basic laws of investment risk and return—there is still no such thing as a free lunch! In fact, when compared to traditional stock and bond investments, many portable alpha investment structures are much more complex, and the risks more challenging to measure and monitor over time. It is also true that portable alpha strategies necessarily involve the use of derivatives and at least one form of leverage. As such, investment- and operational-risk management is of critical importance. However, the end result can be very powerful and well worth the extra time and effort involved in understanding, evaluating, and investing in portable alpha strategies.

Why all the interest in portable alpha? Investors are more open than ever to new asset classes and new investment strategies, not only due to the fundamental merits of an expanded opportunity set and diversification but also due to an apparent concern about not meeting return targets. Adding fuel to the fire, there are a number of interested parties actively marketing the concept of portable alpha and alpha-beta separation as the solution to the challenges that many investors face.

When it comes to portable alpha investment applications, however, the real problem from the standpoint of investors is that all too many people in the industry seem to grossly oversimplify what is undeniably a complex concept from a number of different perspectives. The complexity and risks may be magnified when the alpha source and beta market exposure have a materially positive correlation, when the management of the two is separated between two or more different managers, or when the alpha source involves material risks that are neither familiar to most investors nor fully measured using traditional risk metrics. This is not to say that portable alpha strategies—including those that involve separate alpha strategy and beta derivatives management—are a bad idea or an unwise investment. Rather, a number of portable alpha strategies or approaches simply require more initial and ongoing due diligence on the part of investors and fiduciaries than might be the case with traditional and more familiar stock and bond investments.

PIMCO has been employing an expanding number of different portable alpha strategies for over two decades and is generally credited with being the first, or at least one of the first, to launch a portable alpha strategy with an alpha source that is entirely independent from the beta market exposure. PIMCO’s StocksPLUS strategy (inception date 1986) is put forth by a number of practitioners and others in the industry as an example that the concept works over long periods of time and multiple market cycles—and clearly we agree.

In theory and in practice, the concepts behind portable alpha allow for improvements in investment efficiency as measured by return per unit of risk, reductions in downside risk, and other relevant real-world metrics that may not be realistically possible in a traditional investment management context. However, we also believe that it is critically important for investors to separate themselves from all of the hype that seems to be surrounding the concept and focus not only on the potential benefits but also on other relevant considerations that may be crucial to the long-term success of different portable alpha applications. The goal of this book is to do just that: explore the potential benefits, applications, costs, and risks, together with the practical aspects of implementing this important yet often complex investment application that has come to be known as portable alpha.

We recognize that the pace of market innovation seems to accelerate every day, not to mention the constantly changing market dynamics. Combine this with the fact that the portable alpha investment application in its broadest form can be extended to just about every aspect of investment management if not every investment strategy—and the topics that might be covered are almost endless. As a result, we are certain that there are (or will be) relevant considerations that we may have unintentionally omitted or not explored to the level of depth that may be required. To this end, we most certainly welcome constructive feedback for purposes of both future editions of this book and also our ongoing client-driven research and communication.

Sabrina Callin

Newport Beach, California

August 2007


Content and associated objectives, by chapter

Chapter 1: Overview of Book and Key Concepts

Introduce the key concepts associated with portable alpha that are important for investors to grasp, and provide an overview of each of the chapters in the book.

Chapter 2—Portable Alpha Definitions and Trends

Review the details behind portable alpha investment applications, the evolution of portable alpha strategies over time, and the primary benefits of porting alpha.

Chapter 3:—Back to the Basics: Investments 101

Underscore the fundamentals of investing that are most relevant in a portable alpha context with a central focus on the related concepts of risk and return and the benefits of diversification.

Chapter 4—Asset Allocation and Portable Alpha

Explore the value that investors can derive by moving away from the classic approaches to asset management toward a framework that allows for improvements in diversification and risk budgeting through innovative approaches including portable alpha.

Chapter 5—Alpha, Beta, and Alpha-Beta Separation

Provide clarification with respect to the terms alpha and beta together with the key associated concepts for investors to consider in an alpha-beta separation and portable alpha context.

Chapter 6—Global Sources of Portable Alpha, Associated Risks, and Active Management

Highlight the different potential sources of incremental return that are available globally together with the associated investment risks, correlations and the potential value of skilled active management.

Chapter 7—Derivatives-Based Beta Management

Detail the investment and operational complexities together with the related costs and risks associated with the derivatives-based beta component of portable alpha strategies.

Chapter 8—Portable Alpha Implementation

Review integrated, semibundled, and segregated approaches to portable alpha implementation, including the structural elements and associated cost, investment risk, and operational risk considerations.

Chapter 9—The Real Holy Grail: Risk Measurement and Management

Focus on the real key to successful portable alpha strategy implementation—prudent ongoing risk measurement and management.

Chapter 10—Liability-Driven Investing

Explore liability-driven investing including approaches that incorporate the portable alpha and alpha-beta separation concepts.

Chapter 11—Portable Alpha Theory and Practice: Wrapping It Up

Summarize the key concepts put forth in the book with the goal of helping investors navigate portable alpha theory and practice.

Epilogue: Portable Alpha—The Final Chapter: Schemes, Dreams, and Financial Imbalances: “There Must Be More Money.”


Specific to the Portable Alpha Theory and Practice: What Investors Really Need to Know book project, we would like to acknowledge:

As is the case with most major endeavors, this book project was a team effort not only on the part of the authors and individuals noted above, but also with respect to other key professionals at PIMCO behind the scenes, each of whom invested a tremendous amount of time, energy, and effort, as follows:

Of course, our knowledge on portable alpha and the related areas covered in this book certainly should be credited to many others, including but not limited to: