Timothy B. Barrett, Donald Pierce, James Perry and Arun Muralidhar look at the structure of dynamic beta management and its implications
We assume that a fund allocates 99% of its assets to any of the reference portfolios and then 1% is kept as cash margin for a dynamic beta programme. Each of these new portfolios is referenced by adding “A” to the title so Portfolio IA is equal to 99% invested in Portfolio I and 1% invested in dynamic beta. This is an extreme analysis as we are assuming collateralisation that exceeds what is required by a substantial amount; since these programmes are run with futures, the cash requirement is much lower. Table 3 demonstrates how a simple 1% allocation to dynamic beta results in higher returns, lower volatility of returns, lower drawdowns, and even better ratios of success and drawdown to volatility. The same results are achieved in an asset-liability context given the positive correlation to liabilities and negative correlation to assets.
Most SAAs confuse strategic asset allocation with static asset allocation. There are many embedded risks in portfolios made up of traditional assets or even hedge funds that are not diversified away through more creative combinations of these assets (e.g., risk parity). Dynamic beta programmes manage primary beta risk in the portfolio and through effective design lower the volatility and/or drawdown of the reference portfolio whether it is asset or asset-liability focused. The way to achieve this unique result is to design a program that tactically tilts the beta and which earns a positive return, but which has the unique correlation properties. The economic concepts to develop such rules are in the public domain, the frequency of execution can be as low as monthly and these programs can be designed to make tilts on just the typical assets in an average SAA. In short, any investor can engage in the development of a dynamic beta program, and can get paid to manage risk!
Timothy Barrett is director of pension investments, worldwide, Eastman Kodak Company
Arun Muralidhar is chairman and founder, AlphaEngine Global Investment Solutions, LLC.
James Perry is senior investment officer at San Bernardino County Employees’ Retirement Association
Donald Pierce is chief investment officer of San Bernardino County Employees’ Retirement Association
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