EUROPE – Mercer Investment Consulting is offering a new concept for pension fund managers that involves the use of derivatives in constructing portfolios of independent alpha and beta sources.

The concept, dubbed “alpha transport” involves “marrying the optimal combination of manager skill (i.e. alpha) together with the desired strategic asset allocation (i.e. beta)”. The application of “alpha transport” to the specified portfolio will allow the efficient and effective allocation of the overall risk budget, says Mercer.

Traditionally, investors look first at asset allocation, and then assess the potential alpha available, but the “alpha transport” concept, means that “alpha does not have to be held hostage to beta,” says Ralph Frank, a senior consultant at Mercer IC in the UK.

“Portfolio management techniques have evolved sufficiently such that it is now possible to reliably separate alpha and beta and attempt to capture them independently of one another,” Frank says.

“In doing so, the aggregate investment structure can now target the combination of alpha and beta that represents the desired risk and return trade off.”

Alpha transport is implemented through the use of derivatives – generally futures and/or swaps, which serve to overlay the alpha generated onto the base asset class beta, but investors must consider and understand the risks associated with using the tools, says Mercer.

The strategy, whilst not applicable to all pension funds, may be a viable option for investment of parts of some funds, says Mercer. The consultant is currently talking to clients and managers about the concept.