David W. Schulz, president of Convergence Investment Partners, explains his firm’s concept of “efficient beta” in this video. “All investors – implicitly or explicitly – target a certain amount of beta, or market exposure, in their portfolios,” Mr. Schulz says. The questions investors have to answer, then, are: 1) How to achieve the desired amount of beta exposure, and 2) How to maximize return-on-capital for the targeted level of beta.
One way, according to Mr. Schulz, is to seek exposure to one of his firm’s strategies, which always have a 100% net-long beta exposure, even though they have short-selling components. By allocating 12% to a 1.0 beta fund, investors can achieve a beta of 0.12, for example, if that’s their target. Alternatively, they could combine exposures to varying beta-level products to achieve their desired net-beta exposure, in the aggregate. Beta efficiency, however, is based on how little capital needs to be allocated in order to gain the desired level of beta, and how much alpha is generated on the beta exposure.