Two Questions management, efficient, otherwise, because, however

John10

1.)I did a quiz today that said alpha/beta separation is best for efficient markets. I thought active management thrived on inefficient markets, otherwise you would just index?

Technically wouldn't this need both efficient and inefficient markets? Inefficient for the alpha portion and efficient for the indexed portion?

2.)Also.... "portfolio managers should be aware, however, that some institutions may not be able to use an alpha-beta separation approach because of institutional constraints"

This ^^^ was correct.... which I know bc they are limited on shorts so i put "correct" (bc i thought its what they wanted), but i also was thinking in the back of my head "yah but there are ways around that"...

and the answer even goes on to explicitly state: "these investors, however, could create similar exposure as the alpha and beta separation approach if they can trade equity futures. For example, suppose the investor wanted a beta from large-cap US stocks and alpha from European equities. The investor could take a long position in the S^P 500 index and invest with a European equity manager to generate the alpha. To become market neutral in the European equity market, the investor would then short a futures contract based on European Equities"

So my question is, how can they label the statement correct if the fkng answer says that it can be worked around?

aidebaobao

1) Alpha beta separation may not work in inefficient market because Inefficiency can be deepen.
For example, you have constructed Alpha beta Separation Position by Long S&P Futures + Long Toyota Stock + Short TOPIX Futures.
If Market is inefficient, Toyota Stock may underperform TOPIX so you can loose your money in alpha position.

Alpha Beta Separation focus on Alpha, and you don't have to outperform S&P.

This is why they said statement 1 is correct.(Opinion)

2) may be "some" investors has constraints, and some of "some" can trade equity futures, not all of "some"..

Good luck on your exam!



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 11:55PM by overdope.

Valores

Yah, but those "some" investors can get around the problem delineated in the answer, so how can they claim it's correct when they directly contradict themselves in the answer?

lcai

Alpha beta separation must be done in places that have the ability to short futures. Most inefficient markets have too much unsystematic risk and limited ability to short the contracts.

i.e. me shorting the futures doesn't get rid of unsystematic risk of the companies involved or I can't short the futures.

i.e.2 I want to have alpha beta separation on Malaysian small caps, I can get the alpha from Malaysian small caps no problem via good manager but it is hard for me to separate out the alpha as I can't get rid of the beta.

IAmNeil

fair enough. do you think the second question is a bit sketch?

Windjammer

I was under the impression Alpha Beta separation was setup for institutional constraints on short selling.