What is an Alternative Beta?

Alternative beta is a term for a kind of risk that investors face. The phrase is used to refer to a type of investment strategy. Investors who try to profit from alternative beta investing expose themselves to risk in different markets than those using traditional beta strategies, using different methods than those used by alpha investors.

Investors use the Greek letters alpha and beta to refer to the different aspects of risk they face in their investments. Alpha is the risk from an individual company’s performance. Investors who pursue alpha try to pick individual stocks so that they can outperform the market. Beta is systematic risk, or the risk inherent to the market. Investors who seek beta profits try to buy and sell assets at profitable times.

Traditional beta is the systematic risk that investors face in the course of their usual investments, as in debt and equity markets. Exposing one’s portfolio to market risks rather than stock picking, but managing which market risks affect the portfolio, is an alternative beta strategy. It involves choosing different markets in which to place investments. The same tactics of traditional beta investing, however, like market timing, are used in this type of investment strategy.

The definition of alternative beta is vague because different markets are traditional according to different investors. Some investors believe that investing in traditional markets in non-traditional ways, such as pairing debt or equity investments with derivatives, exposes investors to alternative beta. Others limit their definitions to the market risks in non-traditional markets investors can use to diversify their investments. These can be as varied as emerging international markets, fine art and old wines.

One of the most common contexts in which alternative beta is discussed is the world of hedge fund investing. Hedge fund managers typically tout their skills by attributing their returns to their skill at picking stocks; that is, they claim that their results are a result of alpha strategies. Some analysts believe that the supposed alpha of hedge fund investing is actually a type of beta. According to this theory, investing in a hedge fund exposes an investor to the risks inherent to hedge funds rather than those specific to a particular manager.

Investors choose to pursue alternative beta because it affords different opportunities than traditional beta or alpha investing. Some prefer the methods of beta investing to those of alpha investing because they think that the profits from alpha strategies are too uncertain or a matter of luck. Branching out from traditional beta to alternative enables investors to diversify their portfolios. They can continue to use methods with which they are comfortable while uncovering new opportunities to time markets.