Strategic Investment Group

Separating Alphas and Betas:
Why Breaking Up is Hard to Do

June 2005

Although simple in concept, the execution of a portable alpha strategy is hard in practice. First among the devils in the details is the challenge of separating alpha from beta. This is an intricate process because the two components of return are not as easily distinguished from each other in practice as they are in theory. By definition, they are differentiated by their correlation with a market, or lack thereof. But correlations change constantly, and they tend to increase suddenly at inopportune times, particularly during severe market declines. Moreover, systematic factors relating to market and style cycles, not to mention luck, can be mistaken for manager skill in selecting securities.

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