Abstract
Most U.S. institutional portfolios have surprisingly similar betas and similar overall volatilities. Beta assumes an implicit beta for each asset class that is based on its co-movement with U.S. equities. This “total beta exposure’ to equities, as the primary risk factor in most portfolios, accounts for 90% or more of volatility even in highly diversified funds with a low explicit allocation to equities. The implicit beta values determine corresponding implicit alphas that can add to expected fund return and yet have a minimal impact on total fund volatility. These implicit alphas are passive, in that there is no presumption of a positive outcome from direct active investment. Unlike the zero-sum active alphas that presume superior investment skill and must be “hunted,’ the implicit alphas are passive and non-zero-sum in nature, and rather can be “gathered’ through the allocation process.
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