Handbook of Market Risk

Chapter Eleven

Alternatives Investment: Targeting Alpha, Idiosyncratic Risk

The active management is designed to outperform the market of reference (called “benchmark”) of the managed portfolio. The manager, using various analytical tools, will select in a discretionary way products, securities, or sectors more likely to grow faster than the market. The excess return gained above the benchmark is usually called alpha.

Within the active management, there are different styles that can be classified according to the level of risk, geographic or sectoral portfolio distribution, the type of products used, or the investment time horizon.

These funds can also be handled in a “traditional” or “alternative” manner, using fundamental or quantitative criteria. Generally, many transactions are carried out in such a background and therefore the costs management becomes relatively high.

Conversely, the passive management or index is designed to faithfully replicate the performance of a market of reference (for example, an index such as the Dow Jones or the CAC 40). The method used is generally to replicate in miniature the benchmark index; for example, a CAC 40 Fund will consist of 40 values of the index, weighted according to the size of their capitalization.

This type of management requires significantly less search work for the manager, because it is often partially automated. In addition, fees are generally lower due to fewer transactions for its management.

11.1 Passive Investing

There ...