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Active Alpha: A Portfolio Approach to Selecting and Managing Alternative Investments

ISBN: 978-0-471-79132-4
384 pages
August 2007
Active Alpha: A Portfolio Approach to Selecting and Managing Alternative Investments (0471791326) cover image
Praise for Active Alpha

"Active alpha is the quest for every sophisticated investor. This book covers all of the key alpha sources currently mined by active managers, reduces the complexity of the subject, and helps the investor get started in the right direction."
-Mark Anson, Chief Executive Officer, Hermes Pensions Management Ltd.

"Long-held traditional methods for investing large portfolios are giving way to new processes that are designed to improve productivity and diversification. These changes find their locus in the sometimes overly mysterious world of absolute return strategies. In this book, Alan Dorsey demystifies that new world and provides a guiding pathway into the future of professional portfolio management. This is an important read for any investor who plans to succeed going forward."
-Britt Harris, Chief Investment Officer, Teacher Retirement System of Texas

"With great lucidity, Alan Dorsey's book, Active Alpha, fills an important void by identifying the relevant institutional features of this complex subject and by providing a unifying analytic framework for understanding and constructing portfolios of alternative assets. For anyone investing in the alternative class, from the new student to the experienced practitioner, Active Alpha is a necessary read. I am recommending it to everyone I know with such an interest, and it is destined to become a much thumbed reference on my shelf."
-Steve Ross, Franco Modigliani Professor of Financial Economics, Sloan School, MIT
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Preface.

Acknowledgments.

About the Author.

Part One. Alternative Investments and Investors.

Chapter 1. Introduction.

Integration of Alternative Investments and Traditional Asset Classes through Factor Analysis.

Approaches to Portfolio Construction.

The Identification of Alpha and Beta in New Investment Strategies.

What the Future Holds.

Summary.

Chapter 2. Investors in Alternative Investments and the Necessary Ingredients for a Successful Program.

Types of Investors and Their Approaches to Alternative Investments.

The Necessary Ingredients for a Successful Alternative Investment Program.

Support from Investment Management Firms and Consultants.

Investors Deciding To Minimize the Use of Alternative Investments.

Summary.

Chapter 3. Hedge Funds.

Performance and Diversification Attributes.

Market Segmentation.

Hedge Fund Strategies.

The Construction of a Segregated Portfolio of Hedge Funds.

Summary.

Chapter 4. Private Equity.

Performance and Diversification Attributes.

Dispersion of Returns.

Private Equity Strategies.

The Construction of a Segregated Portfolio of Private Equity.

Summary.

Chapter 5. Real Estate.

What Is the Attraction?

Real Estate Strategies.

The Construction of a Segregated Portfolio of Real Estate.

Summary.

Chapter 6. Currency, Commodities, Timber and Oil & Gas.

The Qualitative Determinant of Returns.

The Attraction of Currency.

The Attraction of Commodities.

Currency and Commodity Strategies.

The Attraction of Timber.

Timber Strategies.

The Attraction of Oil & Gas.

Oil & Gas Strategies.

The Construction of a Segregated Portfolio of Currencies, Commodities, Timber and Oil & Gas.

Summary.

Part Two. Alternative Investments in Traditional Portfolios.

Chapter 7. The Migration of Hedge Funds into the Private Equity Realm.

Are Hedge Funds Gaining Market Share from Private Equity?

How Well Suited Are Hedge Funds To Private Equity Investments?

The Power of Compounding. A Comparative Advantage for Private Equity.

The Fee Differential between Hedge Funds and Private Equity.

Alternative Investment Fee and Term Components.

Summary.

Chapter 8. Cash Flow Forecasting and its Implications for Rebalancing.

Alternative Investment Cash Flow.

Asset Allocation. Achieving Policy Targets and Rebalancing.

Cash Flow Forecasting Tools.

Portfolio Rebalancing Tools.

Summary.

Chapter 9. Leverage and Portable Alpha.

Leverage.

Portable Alpha.

What Is Portable Alpha?

The Benefits and Issues with Portable Alpha.

Reevaluating the Premise for Portable Alpha.

The Use of Hedge Funds in Portable Alpha.

Alternative Thinking about Alpha.

Summary.

Chapter 10. Factor Analysis. The Rationale.

Marketplace Changes That Warrant Factor Analysis.

The Asset Class Concept.

Alternative Investments and Factor Analysis.

Problems with Selecting Vehicles for Alternative Investment Portfolio Construction.

Quantitative Building Blocks.

Risk Budgeting Using Factors.

Beyond Traditional Asset Class Risk Budgeting.

Qualitative Independent Variables.

Illiquidity Factor.

Summary.

Chapter 11. Factor Analysis. The Findings and Discovering Active Alpha.

Time Series Delineation and Issues.

Mean Variance Optimization.

Problems Using Mean Variance Optimization with Alternative Investments.

Regression Analysis with Alternative Investment Factors.

Regression Analysis Results and Observations.

Problems with Conducting Regression Analysis on Alternative Investments.

Factor Optimization.

Active Alpha vs. Passive Alpha.

Problems with Factor Optimization.

Synthetic Portfolios of Alternative Investments.

Factor Measurement and Risk Monitoring.

Summary.

Appendix. Regression Methodology.

Notes.

Glossary.

References.

Index.

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ALAN H. DORSEY is a Managing Director and Alternative Investment Strategist at Lehman Brothers. He is cohead of Portfolio Advisory for the Private Investment Management group that serves Lehman's high-net-worth clients and head of Portfolio Strategy for multi-asset class institutional portfolios with a focus on alternative investments. Prior to joining Lehman Brothers, Dorsey was managing director and director of non-traditional investments and research at RogersCasey, a leading consultant to pension funds and other institutional investors. He holds a BA in economics from Wesleyan University and is a Chartered Financial Analyst. Since 1997, Dorsey has served as a member of the investment committee for Wesleyan University, where he is a past trustee. He became a trustee for the Lehman Brothers defined benefit pension plan in 2007.
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