Some financial firms are touting the use of exchange-traded funds in portable alpha strategies, but institutional investors are not yet sold on the approach.
ETFs are listed and traded like equities, and track indexes of stocks, bonds or other assets. Institutions can use them for beta, or market exposure, and then add alpha through hedge funds, fixed-income or long-short strategies. On the upside, the investor benefits from perfect tracking against the index. However, they may run into higher custody and asset management costs, as compared with a common alternative such as a futures contract.
At Goldman Sachs & Co., New York, the level of inquiry about ETFs in portable alpha strategies by institutional investors is "significant and has increased dramatically" from a year ago, said Barbara Mueller, a vice president at Goldman, one of the biggest ETF market makers. She added there is still a higher level of inquiry than implementation.
The majority of the investors implementing portable alpha make direct investments in the alpha and use futures or swaps for their beta exposure, said Maarten Nederlof, managing director of K2 Advisors LLC, Stamford, Conn.
"Investors who do the opposite, who borrow money for the alpha and make direct investments in the underlying beta portfolio, might consider ETFs but are more likely to use a low-cost index fund if they have access to that as a large investor," he said.