The investment cliche that “all correlations go to one in a crisis” is untrue because it refers to asset class labels, rather than the “essential betas” which lie beneath them, according to US manager First Quadrant.

A co-director of global macro at First Quadrant, Dori Levanoni, said the manager’s Essential Beta strategy was proudly “informationless”, in that it did not attempt to make forecasts, but instead tried to capture the growth of global GDP in a risk-limited, inflation-protected fashion.

Known historically as a quantitative alpha shop, the partner firm of Affiliated Managers Group turned its attention to beta after August 2007, when many of the world’s quants discovered they were holding similar bets, despite the apparent “diversity” of their portfolios.

“The term beta is routinely treated as synonymous with the term ‘asset class’, and by treating it this way, the term is divorced from the concept of systematic risk, or non-diversifiable risk that made it important in the first place,”  First Quadrant’s chief investment officer, Max Darnell, said in a paper entitled “Rethinking Beta” last year.

“By reuniting the term with its original meaning, we will come to see that there is much more to asset allocation, and much more to the principle of diversification, than simply ‘spreading’ risk across different asset classes. Asset allocation should be approached more actively with intentions to shape and mold combinations of assets and asset classes into the beta we need.”

“There are no such betas as ‘stock market betas’, ‘bond betas’,  ‘commodity betas’ or ‘hedge fund betas’. Asset classes are not betas, and we should cease equating the two. Beta is what results from combining assets and/or asset classes.”

Levanoni said this thinking resulted in portfolios somewhat simpler than global macro strategies which aimed to produce alpha.

First Quadrant’s Essential Beta portfolio will hold 30 to 40 positions only at any one time, usually via futures contracts to achieve the transparency and liquidity it requires.

The growth intentions of the portfolio are met by a basket of equity-index futures including developed markets (equally weighted between major markets), small-cap equities, emerging markets and REITS.

Diversification and deflation hedging are provided by long-duration zero coupon bonds, which are syntheticallly created by using futures.

The Essential Beta portfolio is rounded out by real assets for inflation hedging, including a diversified basket of commodities, and Treasury Inflation Protected Securities.

Levanoni said the exposures were dialled up and down to keep a consistent level of growth exposure and risk, for instance a sharp rise in inflation would lead to a reduction in the bond exposure.

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