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B. Venkatesh

IT HAS become difficult for traders to accumulate stocks in the market without immediately impacting prices. After all, when everybody wants to buy, sharp increase in volumes in a stock will not go unnoticed. Such investor behaviour has implications for active portfolio management. For in such a market, portfolio alpha is likely to become portfolio beta very soon. What does that mean?

Assume that your portfolio contains only HLL. You compare this portfolio to an equity index that also has only HLL. This means that your portfolio and the benchmark index will move one-to-one if you buy HLL shares and hold them. Your portfolio's beta is one.

Now, after six months, we find that your portfolio has delivered 20 per cent while the index has returned only 15 per cent. How can that be possible considering that both contain only HLL?

The reason is that you actively bought and sold HLL shares. As you were fortunate in timing your purchases and sales, you were able to beat the benchmark index. In financial parlance, you generated excess returns.

Suppose we do a simple regression analysis. The excess return that you have generated is called the portfolio alpha, represented by the constant in the regression equation.

Assume that you followed a simple rule of buying and selling HLL. You bought every Monday and sold every Friday. A bunch of astute traders observe this and now decide to piggyback your trading rule. And looking at them, some more join later.

Soon, you may have many people buying HLL on Monday and selling the shares on Friday. So, your trading rule may no longer be profitable. And that means that you will be unable to generate excess returns. That is when your portfolio alpha becomes portfolio beta!

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