Retirement Solutions | Investment Insight
November 14, 2023
Paying for Alpha but Getting Beta?
Joseph Moroney | Partner, Co-Head of Multi-Credit
Rob Bittencourt | Partner, Co-Head of Opportunistic Credit
Akila Grewal | Partner, Head of Credit and FIG Product
Benchmark constraints can create unintended concentration in fixed-income portfolios, hindering alpha-generation potential. Relaxing these restrictions may enhance diversification and help unlock potential excess returns. In this paper, we illustrate how integrating less-constrained or unconstrained strategies can help enhance long-term risk-adjusted performance.
Key Takeaways
- Fixed-income portfolios relying on traditional strategic asset allocation models could be exposed to hidden risks. As most traditional active and passive strategies are benchmarked to the same indices, market participants can end up with significant holdings overlap and suboptimal portfolio allocations. This benchmarking strategy risks degrading performance namely through increased concentration across holdings, higher volatility, lower returns, or worse—a portfolio paying for alpha but only receiving beta.
- We believe that relaxing these benchmark constraints in fixed-income portfolios can generate true alpha and higher risk-adjusted returns. This can be achieved through allocations to unconstrained strategies that extend the investable universe across sub-asset classes in both public and private markets. We believe it is important to consider managers who approach portfolio construction from a bottom-up perspective, which can translate to differentiated investment portfolios with lower correlation and increased performance over time.
- Loosening constraints can also provide active managers the flexibility to position portfolios dynamically throughout the market cycle, minimizing default and other risks, and creating new opportunities for potential alpha generation.
- In this paper, we examine how benchmarking issues can undermine performance in fixed-income portfolios. We also use an illustrative, simplified, non-optimized portfolio based on publicly available data to demonstrate how integrating less-constrained or unconstrained strategies can enhance long-term risk-adjusted returns.
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