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Alpha Generator

Reviewed by Annapoorna | Updated on Sep 30, 2020

Catalogue

What is Alpha Generator?

An alpha generator refers to any security that generates excess returns or returns higher than a pre-selected benchmark with no additional risk when added to an existing portfolio of assets. Any security can be an alpha generator, including government bonds, foreign stocks or derivatives like stock options and futures. The expansion of investments into a new base can also lead to new alpha generators.

Alpha Generator Explained

Often alpha generators come from widening the investment horizon. For example, the addition of international investments to extend the portfolio of an investor may lead to higher returns from both fixed income and equity investments.

Alpha can be a measure of the returns a portfolio produced on a risk-adjusted basis more than the return estimated by the capital asset pricing model. Therefore, an investor can add to portfolio returns measurably when expanding their investment horizon to include new types of alpha generators.

All of this can be done using modern portfolio theory, which allows targeted expansion of the investment horizon. It can result in an upward shift of the efficient frontier and capital market line when adding alpha generators.

With new alpha generators affecting the capital market rows, a portfolio of investors may anticipate higher returns through allocations that now incorporate new alpha-generating securities with reduced risk into the portfolio mix.

Examples of Alpha Generators

One way of adding a targeted group of alpha generators to a portfolio is through international investment. In particular, emerging market investments are one area that can be widely regarded as alpha-generators. With some additional risk, both emerging-market debt and emerging-market equity offer higher returns than average global benchmarks.

An investor who extends their overall portfolio to include emerging market assets will eventually move their capital market line higher. It can be done by adding emerging market debt into the more stable portion of their portfolios and emerging market equity into the higher risk portions of their portfolio.

Other market sectors can add alpha substantially through more concentrated investment. Initial Public Offerings (IPO) can be a capable alpha generator. This market group offers high growth potential from enterprises, which have set significant momentum.

Investors may choose to invest in individual stocks, IPO funds, or index funds tracking IPOs. Some investors can also consider the substantial generation of alpha from derivatives use.

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