/institutional/perspectives/portfolio-strategy/alphas-role-in-optimizing-asset-allocation

Alpha’s Role in Optimizing Asset Allocation

Positive alpha, which is difficult to produce, signals that an active management strategy is generating returns in excess of its beta-implied returns.

September 28, 2021


Report Highlights

  • Diversified fixed-income portfolios should contain both alpha and beta performance drivers.
  • Beta reflects a strategy’s risk relative to a broader market index, and alpha measures a strategy’s ability to generate returns in excess of the index.
  • Positive alpha is difficult to produce, while beta is easily and often cheaply sourced in passive strategies.
  • Since inception, many of Guggenheim’s active strategies have delivered positive alpha while maintaining lower betas than their benchmarks.
  • Asset allocators can optimize returns by selecting and scaling high alpha products to achieve the desired beta of their diversified portfolio.

The active vs. passive debate has raged for decades in the investment management community: Passive products offer cheap exposure to broad market indexes, while active strategies strive to outperform those benchmarks. Guggenheim is dedicated to managing strategies that target high alpha and strong risk-adjusted returns. Simultaneously, our strategies have generated low betas relative to their respective category benchmarks. This report identifies the beta versus alpha return drivers of our strategies to help asset allocators understand how our products can be most effective in the context of their broader portfolios.

Alpha and Beta

Alpha and beta are measurements of the performance of a portfolio strategy (or individual security) relative to the market. A strategy’s beta measures how much its returns are driven by the overall market, and alpha measures how much its returns deviate from market returns.

A beta value equal to 1.0 indicates that the strategy has the same systematic risk as the broader market, while a beta of more or less than 1.0 indicates a strategy has more or less risk than the market. For example, a strategy with a beta of 1.2 has 20 percent more systematic risk relative to the broad market, meaning if the market rises or falls 1 percent, the portfolio would be expected to rise or fall by 1.2 percent.

Positive alpha signals that a strategy is generating returns in excess of its beta-implied returns through active management. Alpha is uncorrelated to broad market moves and therefore is an important component of diversified fixed-income portfolios. Positive alpha is difficult to produce and few managers have proven track records of consistently generating excess returns.

Optimizing Portfolio Construction with Alpha and Beta

Guggenheim’s unique approach to portfolio construction and security selection has led to alpha generation with lower betas than respective strategy benchmarks over time. At the strategy level, a lower beta can help protect portfolios against market downturns and lead to outperformance versus the broader benchmark. Asset allocators can scale exposure to our strategies to seek specific beta targets in their broader portfolios. For example, our Core Plus strategy has generated a 0.85 beta versus the Bloomberg U.S. Aggregate Bond index (the Agg) over the last five years. If a beta of 1.0 is desired versus the Agg, investors could apply approximately 20 percent leverage to the allocation . This action would scale up exposure to positive alpha drivers and may help balance an investor’s beta/alpha mix.

Guggenheim Expands the Toolkit to Generate Alpha

In addition to determining the balance between alpha and beta strategies in a diversified portfolio, asset allocators should also consider how the alpha is generated, how repeatable the alpha generation process can be, and the amount of risk that is taken to generate positive alpha.

While weightings across fixed-income sectors within the Agg are largely determined by issuance trends and the amount of debt outstanding within each sector, Guggenheim determines weightings to different sectors based on our evaluation of risk and relative value. We believe that taking advantage of investment opportunities available in the universe beyond the benchmark generates alpha, and the opportunity for higher alpha increases with the size of that investment universe.

The Agg, the most widely used benchmark for the broad U.S. fixed-income market, largely comprises U.S. Treasurys, Agency mortgage-backed securities (MBS), and investment-grade corporate bonds. It represents less than half of the available sectors in the U.S. bond market, omitting fixed-income sectors including many asset-backed securities (ABS), collateralized loan obligations (CLOs), non-Agency residential MBS, bank loans, high-yield corporate bonds, and municipal bonds, in addition to securities maturing in less than a year or with floating-rate coupons.

The Bloomberg U.S. Aggregate Is Less Than Half the Picture

The Agg represents less than half of the available sectors in the U.S. bond market, omitting fixed-income sectors including many asset-backed securities (ABS), collateralized loan obligations (CLOs), non-Agency residential MBS, bank loans, high-yield corporate bonds, and municipal bonds.

The Bloomberg U.S. Aggregate Is Less Than Half the Picture

Source: Guggenheim Investments, SIFMA, Wells Fargo, S&P LCD, Bloomberg. Data as of 3.31.2021. Excludes sovereigns, supranationals, and covered bonds.

There are several investment characteristics we look for to generate outperformance versus the benchmark:

  • Sectors underrepresented in benchmarks including ABS and other forms of structured credit should be a part of many fixed-income investment strategies. These securities generally have higher yields than similarly rated corporate bonds and investor-friendly features that may help protect against credit losses, while providing lower duration risk and lower correlation to other securities found in the Agg. We focus on structured credit due to its potential for higher expected returns and its ability to increase portfolio diversification while decreasing the overall volatility of a fixed income portfolio.1
  • We find value in smaller issuers and under-followed sectors that exist outside the benchmark. Searching for value outside the benchmark requires additional resources and differentiated expertise to uncover investments offering attractive returns without taking on undue credit risk. Senior loans, as an example, especially from middle-market issuers generally have limited analyst coverage compared to public securities and therefore tend to offer higher yields. While at the same time, many loans have credit enhancements that may mitigate credit risks.2
  • Securities with greater complexity premium can earn risk-adjusted returns in excess of the benchmark, but evaluating these opportunities requires diligent active management with robust analytical resources. For example, preferred securities do not fit neatly into major corporate credit indices and can have complicated structural characteristics with unique return profiles.

Diversification does not guarantee a profit or protect against a loss in declining markets.

1. Asset-backed securities (ABS) and other forms of structured credit are complex investments and not suitable for all investors. Investing in fixed-income instruments is subject to the possibility that interest rates could rise, causing their values to decline. Investors in ABS generally receive payments that are part interest and part return of principal. These payments may vary based on the rate at which the underlying collateral is repaid. Some ABS may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk.
2. Senior loans are often below investment grade, may be unrated, and are subject to risks such as credit risk, interest rate risk, counterparty risk, and prepayment risk.

Deeper Dive: Guggenheim’s Alpha Generating Track Record

Guggenheim offers a broad array of fixed income and alternative strategies that have produced positive alpha, low beta, and excess return.

Delivering Alpha

Guggenheim’s broad fixed-income strategies, such as Core Plus and Multi-Asset, have produced positive alpha, low beta, and excess return.

Delivering Alpha

Source: Guggenheim Investments. Five-year period ending 6.30.2021. Past performance does not guarantee future returns. 1. Against the Bloomberg U.S. Aggregate Index and versus the eVestment U.S. Core Plus Fixed-Income Universe with a total of 137 observations. 2. Against the ICE BofAML USD 3-Month Deposit Offered Rate Constant Maturity Index and versus the eVestment U.S. Unconstrained Fixed-Income Universe. 3. Against the Bloomberg U.S. Intermediate Aggregate Index and versus the eVestment U.S. Intermediate Duration Fixed-Income Universe with a total of 199 observations. 4. Against the ICE BofAML U.S. High Yield Master II Constrained Index and versus the eVestment U.S. High-Yield Fixed-Income Universe with a total of 228 observations. 5. Against the Credit Suisse Leveraged Loan Index and versus the eVestment U.S. Floating-Rate Bank Loan Fixed-Income Universe with a total of 94 observations. 6. Against the FTSE/NAREIT Equity REITS Index and versus the eVestment U.S. REIT Universe with a total of 57 observations. Since the U.S. Risk Managed Real Estate Equity Composite is not currently in the eVestment database, we are comparing it against the universe we feel would be the most appropriate if it were in the database.

Sharpe Ratios and Risk-Adjusted Returns

Guggenheim’s strategies have a strong track record of generating high risk-adjusted returns, as evidenced by the Sharpe Ratios for many of the firm’s strategies.

While breaking down returns into alpha and beta is important for understanding the systematic versus idiosyncratic risks investors that are taking, the Sharpe Ratio is another helpful measure of the quality of returns. The Sharpe Ratio quantifies performance in excess of the risk-free rate, adjusted for the risk taken. Beta will tell you how much of returns are driven by risk to the broader market, but it won’t tell you the absolute level of risk. Guggenheim’s investment process seeks to generate high alpha-oriented returns while at the same time minimizing all types of risks. Investors should be just as focused on return of capital as they are on return on capital. The Sharpe Ratio does a good job of measuring this tradeoff.

Furthermore, investors do not need to sacrifice strong absolute returns to generate high risk-adjusted returns. As demonstrated in the chart on the following page, Guggenheim’s strategies have generally outperformed their fixed-income benchmarks in both the Sharpe Ratio and absolute returns.

Five-Year Sharpe Ratio: Manager Universe Comparison

The Sharpe Ratio does a good job of measuring the trade-off between risk and return.

Five-Year Sharpe Ratio: Manager Universe Comparison

Source: RIMES, eVestment Alliance. Data is for the five-year period ending 6.30.2021. Past performance does not guarantee future returns. Performance numbers for time periods greater than one year are annualized. The peer universe chart displays annualized statistics for the composite’s gross performance and the indicated index for the indicated time period and the percentile in which those returns fall within the indicated eVestment Alliance universe (the “Universe”). From top to bottom, each shaded box represents 5th to 25th, 25th to 50th, 50th to 75th and 75th to 95th percentiles of the peer universe, respectively. This information is supplemental information only and complements the Intermediate Core Fixed-Income composite performance presentation and accompanying notes at the end of this presentation. 1. Against the Bloomberg U.S. Aggregate Index and versus the eVestment U.S. Core Plus-Fixed Income Universe. 2. Against the ICE BofAML USD 3-Month Deposit Offered Rate Constant Maturity Index and versus the eVestment U.S. Unconstrained Fixed-Income Universe. 3. Against the Bloomberg U.S. Intermediate Aggregate Index and versus the eVestment U.S. Intermediate Duration Fixed-Income Universe. 4. Against the ICE BofA Merrill Lynch U.S. High-Yield Master II Constrained Index and versus the eVestment U.S. High-Yield Fixed Income Universe. 5. Against the Credit Suisse Leveraged Loan Index and versus the eVestment U.S. Floating-Rate Bank Loan Fixed-Income Universe. 6. Against the FTSE/NAREIT Equity REITS Index and versus the eVestment US REIT Universe. Data taken from eVestment Alliance on 8.17.2021.

Five-Year Annualized Sharpe Ratio and Returns

Guggenheim’s strategies have generally outperformed their fixed-income benchmarks in both the Sharpe Ratio and absolute returns.

Five-Year Annualized Sharpe Ratio and Returns

Source: Guggenheim Investments, Bloomberg, Credit Suisse, eVestment and Morningstar. Data as of 6.30.2021. Past performance does not guarantee future returns. Sharpe Ratio is the measurement of efficiency between annualized risk-free return (USGG1M) and standard deviation. The higher the Sharpe Ratio, the greater the efficiency produced by the manager. The value of any investment may rise or fall over time. Principal is not guaranteed, and investors may receive less than the full amount of principal invested at the time of redemption if asset values have declined. Individual account performance may be greater than or less than the performance presented for this composite. Gross-of-fee (“Gross”) returns are presented net of non-reclaimable foreign withholding taxes applicable to U.S. investors and includes the reinvestment of income. Performance numbers for time periods greater than one year are annualized. All performance is expressed in U.S. dollars. Indices and benchmarks shown for comparison purposes only. Differences in asset allocation among sectors between the composite and benchmarks may give rise to differences in returns over time. The other indices herein are included for comparison purposes only. This information is supplemental information only and complements the composite performance presentation and accompanying notes at the end of this presentation.

Relative Performance Over Time

Relative Performance Over Time

Source: Guggenheim Investments, Bloomberg, ICE BofA Merrill Lynch, Credit Suisse. Data as of 6.30.2021. Past performance does not guarantee future returns. The value of any investment may rise or fall over time. Principal is not guaranteed, and investors may receive less than the full amount of principal invested at the time of redemption if asset values have declined. Individual account performance may be greater than or less than the performance presented for this composite. Gross returns are presented net of non-reclaimable foreign withholding taxes applicable to the U.S. investors and include the reinvestment of income. Net returns are calculated by reducing gross returns with a model fee that includes (1) the greater of (a) the highest management fee charged to an account in the composite and (b) the highest tier of the current management fee schedule, and (2) estimated performance fees where applicable. Net returns for periods less than 1 year are estimated. Performance based fees are accrued and realized at different time periods, and as such, the net returns for December may be adjusted accordingly. Additional information regarding the calculation of net returns is available upon request. Net returns using actual fees may vary from calculated returns using the model fee depending on, amongst other things, type of client, portfolio size, and performance-based fees. Performance numbers for time periods greater than one year are annualized. All performance is expressed in U.S. dollars. Index Data Source: RIMES, Bloomberg. Alpha figures calculated by eVestment. Composite definitions can be found within the Disclosures at the end of this document.

Important Notices and Disclosures

The Core Plus Fixed-Income Composite is comprised of accounts with a total return objective and a strategy incorporating a higher allocation to non-“core” securities (in terms of sector, credit quality, etc.) than in Core Fixed-Income accounts. Generally, these accounts are broadly diversified portfolios of primarily investment grade fixed income instruments, and allocate opportunistically among sectors and to below investment grade securities where perceived relative value exists. The Intermediate Core Fixed Income Composite is comprised of accounts with a total return objective that invest in broadly diversified portfolios of primarily investment grade fixed income instruments, rotating opportunistically among sectors where perceived relative value exists. The High-Yield Traditional Composite is comprised of accounts that primarily invest in both high-yield corporate bonds and generally 20 percent or less in other sectors including, but not limited to, bank loans, asset-backed securities, mortgage-backed securities and Treasurys. The U.S. Bank Loans Composite is comprised of accounts that predominantly invest in broadly syndicated U.S.-based corporate bank loans. The U.S. Risk Managed Real Estate Equity Composite is comprised of discretionary accounts that are invested in a diversified portfolio of real estate related securities listed or traded on U.S. exchanges including listed Real Estate Investment Trusts (“REITs”), listed Real Estate Operating Companies (“REOCs”) and equity securities of companies whose principal business is the ownership, management and/or development of income producing and for sale real estate. The Multi-Asset Class Composite consists of accounts which seek to maximize total return through a combination of current income and capital appreciation by investing in a wide range of fixed-income (including corporate credit and structured securities), hybrids, equity securities and derivatives selected from a variety of sectors and credit qualities.

The Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. The Bloomberg Intermediate U.S. Aggregate Bond Index is a market index of high quality, domestic fixed income securities with maturities of less than 10 years. The ICE Bank of America (BofA) Merrill Lynch U.S. High Yield Master II Constrained Index is a broad-based index consisting of all U.S. dollar-denominated high-yield bonds with a minimum outstanding amount of $100 million and maturing over one year. The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. The FTSE Nareit Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs.

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

Guggenheim Investments Asset Management (GIAM) claims compliance with the Global Investment Performance Standards (GIPS®). Guggenheim Investments Asset Management (GIAM) is a global investment management firm providing fixed income, equity and alternative investment services primarily to institutional investors and is comprised of the following affiliated entities of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC (GPIM), Guggenheim Partners Europe Limited (GPE), Security Investors, LLC (SI) as of February 2012, and Guggenheim Corporate Funding (GCF) as of December 2019. Historically, Transparent Value Advisors, LLC (TVA) was a separate entity within the firm. Effective July 2016, all TVA assets transitioned to GPIM. To receive a full list of GIAM compliant composite descriptions and/or a GIPS compliant presentation, please contact Institutional@guggenheiminvestments.com.

This material contains opinions of the author, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Investing involves risk, including the possible loss of principal. Stock markets can be volatile. Investments in securities of small and medium capitalization companies may involve greater risk of loss and more abrupt fluctuations in market price than investments in larger companies. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate. Investments in real estate securities are subject to the same risks as direct investments in real estate, which is particularly sensitive to economic downturns.

The strategies discussed herein may include the use of derivatives. Derivatives often involve a high degree of financial risk because a relatively small movement in the price of the underlying security or benchmark may result in a disproportionately large movement, unfavorable or favorable in the price of the derivative instrument. sensitive to economic downturns.

© 2021, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.

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