Active Beta In A Portfolio

Active Beta? What’s that? It is our term for a systematic and relatively passive way to enhance returns by capturing risk premia but at the same time manage risk and provide a real long term edge over standard buy and hold.

Having read countless books and papers preaching the long term upward drift in stock and bond prices we realize that risk premia is a good thing. Of course after having come through the 2000-2003 bear market we also know that if risk premia is good then risk management is even better. After reading Jim Leitners’ interview in the book Inside the House of Money we started to look at different ways we could gain more exposure and safely earn risk premia by using systematic strategies that have us involved in different asset classes.

Currently we have models built to capture risk premia in equities and fixed income. We are still working on ways to capture it in currencies and precious metals/commodities. We have built, bought, and researched several timing models over the years that are based off of technicals, valuations, sentiment, monetary inputs, and any mix of the above. Over time several of these timing models have proven to have a substantial edge over buy and hold especially when it comes to risk control. We have experimented with several different ways to use these models but so far have found that simpler is better and for each bullish model we enter X%. Currently for both fixed income and equities we enter 10% of our position for each model that is bullish using up to 50% of the model portfolio.

Right now we are working on a currency model that takes advantage of the carry trade, but with a risk management filter. We had been struggling to do it in a systematic risk controlled manner but thanks to a post by Macro Man we may have found a solution. If the testing works out we will post an update. As for the Precious Metals/Commodities model portfolio we are working on a CTA technical trend following model. We questioned calling this an Active Beta strategy but after re-reading some research by Bridgewater we decided that with the relative ease (No, it’s not actually easy. But once you have it up and running you shouldn’t have to tweak it much to keep it running.) to maintain it we would include it as Active Beta. Expect more posts on these models in the future as we get further in our research.

Happy Trading,

The Macro Trader

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For further reading on Active Beta and systematic capturing of risk premia, here are some links to go to.
Inside the House of Money Excellent book filled with interviews with leading Global Macro Traders.
Pioneering Portfolio Management Must read book by David Swensen, portfolio manager of the Yale Endowment Fund.
Formula Research Nelson Freeburg builds some of the best systems out there.
World Beta blog Mebane Faber has done a lot of work on systematic methods of reducing risk.
Macro Man blog Macro Man has lots of witty takes on the markets and does quite a bit of solid research.

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