For some enhanced equity index strategies, investors need to keep some cold, hard cash on hand.
That's because enhanced index strategies that port their alpha from short-term bond portfolios onto Standard & Poor's 500 index futures have been hit with realized losses when the portfolios have earned negative returns.
For example, if a beta portfolio with a notional value of $100 million drops 10%, then the investor must pony up $10 million to meet its realized losses. The cost of buying futures is typically the London InterBank Offering Rate. In a long-only portfolio, the investor would simply take a paper loss.
These so-called futures-based S&P 500 strategies, also referred to as cash equitized S&P 500 strategies, represent a popular form of portable alpha strategies.
Firms such as Pacific Investment Management Co., Newport Beach, Calif.; BlackRock Inc., New York; Metropolitan West Asset Management, Los Angeles; and Lotsoff Capital Management, Chicago, all offer futures-based S&P 500 strategies.
Stephen Chin, manager and investment analyst of the $2.4 billion Ministers and Mission Benefits Board, New York, emphasized the importance of keeping a cash portfolio. "The real risk is losing in the beta portfolio," said Mr. Chin. "The alpha portfolio could generate 300 basis points in excess return, but if your beta portfolio is down 2,000 basis points, you still have to pay up a difference of 1,700 basis points."
The pension fund overseen by Mr. Chin has about $300 million invested in a market-neutral based portable alpha strategy handled by INVESCO, New York.