For starters, beta returns refer to returns to the market from passive investing. On the other hand, alpha returns refer to the returns that are above or below market returns, generated by finding mispriced securities.
In a recent note, GMO argued that it is time for asset managers to pull the “alpha lever” in their portfolio after years of dominance for beta returns (or market returns). “In today’s world, we believe investors need to rethink the optimal proportionality between alpha and beta,” GMO said.
According to a study by GMO’s Systematic Global Macro team, the return potential from macro equity alpha is the highest that the team has seen in over 19 years of existence.
GMO explained that the spread between individual forecast by its team for equity markets of various countries has widened due to the disproportionate impact of the Covid-19 pandemic on individual countries and their policy response.
In 2020, where the global economy saw a synchronous plunge due to the onset of the pandemic, 2021 has been different. Today, countries are emerging out of the pandemic at different pace due to uneven distribution of vaccines, emergence of new variants of the virus, and unequal policy response by individual governments.
“In contrast, equity valuations have been inflated everywhere, again, partly because of Covid recovery policies. These extreme valuations have contributed to negative forecasted returns to equity beta; one of the lowest return opportunities we have seen since the Strategy’s inception,” GMO said.
GMO is not only forecasting a dominance for alpha generation over beta market returns in equities, the hedge fund is seeing similar patterns emerge in the bond market.
In a world of negative real yields, GMO forecasts that the return to global bonds will be negative over 7-10 years. In contrast, alpha appears to be becoming more important relative to beta across asset classes.
“The potential beta returns of our two basic assets, equities and bonds, look to be extremely meagre going forward. As such, generating returns for a standard balanced portfolio looks to be extremely challenging,” GMO said.
