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Five Principles to Hold Onto (Even When Your Boss Says the Opposite)

Laurence B Siegel, M. Barton Waring and Matthew H Scanlan
The Journal of Portfolio Management Winter 2009, 35 (2) 25-41; DOI: https://doi.org/10.3905/JPM.2009.35.2.025
Laurence B Siegel
is the director of research in the Investment Division of The Ford Foundation in New York, NY.
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  • For correspondence: l.siegel@fordfound.org
M. Barton Waring
is the chief investment officer, emeritus, for policies and strategies at Barclays Global Investors in San Francisco, CA.
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  • For correspondence: barton.waring@barclaysglobal.com
Matthew H Scanlan
is a managing director and head of the Americas Institutional Business at Barclays Global Investors in San Francisco, CA.
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  • For correspondence: matthew.scanlan@barclaysglobal.com
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Abstract

Although finance practitioners almost universally learn in school that the Sharpe market model, which separates all returns into alpha and beta, is the starting point for a number of key investment insights, they often forget, or disregard, this knowledge once they are on the job. The five most important insights that a practitioner should hold dear, regardless of what the boss says, are 1) the importance of making alpha and beta decisions separately; 2) the zero-sum nature of active management; 3) the different criteria needed to make alpha and beta decisions; 4) the great value of alpha successfully delivered; and 5) the desirability of paying appropriate fees for each return component or, in other words, high fees for alpha, low fees for beta.

TOPICS: Portfolio theory, in markets, exchange-traded funds and applications

  • © 2009 Institutional Investor, Inc.
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Five Principles to Hold Onto (Even When Your Boss Says the Opposite)
Laurence B Siegel, M. Barton Waring, Matthew H Scanlan
The Journal of Portfolio Management Jan 2009, 35 (2) 25-41; DOI: 10.3905/JPM.2009.35.2.025

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Five Principles to Hold Onto (Even When Your Boss Says the Opposite)
Laurence B Siegel, M. Barton Waring, Matthew H Scanlan
The Journal of Portfolio Management Jan 2009, 35 (2) 25-41; DOI: 10.3905/JPM.2009.35.2.025
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  • Article
    • Abstract
    • Principle 1. Investors should think about returns (and risks) in terms of their elemental parts: Beta, alpha, fees and costs
    • Principle 2. Active management, or alpha, is a zero-sum game—but beta is not
    • Principle 3. The criteria for making alpha and beta decisions are completely different, as are the rewards for getting alpha and beta decisions right
    • Principle 4. Alpha, delivered consistently by a truly skillful fund manager, is extraordinarily valuable and worth a high fee
    • Principle 5. It is desirable, and at least generally possible, to separate alpha from beta in practice, and to pay appropriate fees for each
    • 5b. An investor can and should pay alpha (active management) fees for the alpha part of the return and beta (index fund) fees for the beta part of the return
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
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