“Return = Cash + Beta + Alpha” -Bridgewater

What a coincidence, Zerohege just posted a piece where Bridgewater identifies the origin of their All Weather framework. (Here)

Its interesting to read about their thought process and here are a few quotes I found interesting:

“Any return stream can be broken down into its component parts and analysed more accurately by first examining the drivers of those individual parts.”

“Return = Cash +Beta + Alpha”

“Betas are few in number and cheap to obtain. Alphas (ie trading strategy) are unlimited and expensive. … Betas in aggregate and over time outperform cash. There are sure things in investing. That betas rise over time relative to cash is one of them. Once one strip out the return of cash and betas, alpha is a zero sum game. ”

“there is a way of looking at things that overly complicates things in a desire to be overly precise and easily lose sight of the important basic ingredients that are making those things up”

Separately managing the beta and alpha portion of the portfolio seems like a reasonable long term framework. For example, build a stable portfolio (beta) for the majority of your wealth and then overlay that with your desired amount of alpha to spice up the return. But it is important to make sure you understand how the two return streams (beta and alpha) interact fundamentally, for example factors that contribute to the return of the beta portion should be different compared to the alpha portion. It is only through this can the uncorrelated return stream diversify away your risk.

 

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