Portable alpha is the more widely known–and sought–form of investment returns, but endowments, which tend to be in the vanguard of developing investment trends, have started to use a reverse approach called portable beta. The key word is portable–meaning returns from exposure to a market, any market, are separated from over-benchmark profits made by skilled managers.

The revolutionary aspect is the departure from traditional asset allocation, where an investor seeks managers in a certain market in order to allocate a portion of the portfolio to that asset bucket. Hence there’s a search for, say, a mid-cap U.S. equity manager.

With the portable approach, the search for top-performing managers as a source of alpha is separate from the desire to get market return on an asset class, the beta. An investor may want to be in the mid-cap U.S. equity market but also find a promising manager who trades Asian bonds.

With the new paradigm, one gets mid-cap U.S. equity exposure from an index, and hopes to add to the return by investing in the Asian bond fund. Alpha can come from any strategy, which can be exotic enough not to fit into an asset allocation pie chart: The goal is not to get exposure to a market but to receive above-market returns.

“In the last year or two there has been an incredible increase in interest in portable alpha as a way to add expected return to all asset classes, including fixed income and inflation-protected securities,” wrote Morgan Stanley Alternative Investment

Partners Managing Director John Coates in a recent publication from the bank.

He described the method as one of the paradigm shifts in investment management and cited a 2005 survey in which 33% of large companies reported using portable alpha programs and 23% were considering them.

In the same study, 15% of public pension plans participating in the survey were using portable alpha, but 37% said they were considering using the method. That last number suggests there’s a lot of growth to come in such programs.

There are two directions from which you can port the return. You can add alpha to an index, as Harvard University’s former investment chief, Jack Meyer, is doing in his new hedge fund firm.

Meyer’s Convexity Capital is using fixed-income strategies to deliver alpha on top of an index of the investor’s choice. Judging from the $5 billion Convexity raised at launch, there are plenty of takers.

Some endowments that have long been investing in hedge funds and other alternatives are moving from the other direction, adding an overlay of conservative investments to the alpha they’re already getting. In other words, they’re porting the beta.

Morgan Stanley’s Coates warns that the search for sources of alpha requires much skill and work. With that caveat, “Portable alpha strategies can help improve portfolio performance, in terms of return and risk, for institutional investors of all stripes,” he wrote.–Jeff Joseph and Chidem Kurdas

Chidem Kurdas is the New York Bureau Chief at HedgeWorld; Jeff Joseph is managing director of Rydex Capital Partners and serves on the advisory board of HedgeWorld (www.hedgeworld.com), a global provider of hedge fund information and investment products.

Have a question about hedge funds? Feel free to contact Jeff Joseph at jjoseph@rydexfunds.com.

For inquiries about HedgeWorld’s services, e-mail inquiry@hedgeworld.com.

Jeff Joseph is managing director of Rydex Capital Partners and serves on the advisory board of HedgeWorld (www.hedgeworld.com), a global provider of hedge fund information and investment products.

Have a hedge fund question? Contact Jeff Joseph at jjoseph@rydexfunds.com.

For inquiries about HedgeWorld’s services, e-mail inquiry@hedgeworld.com.