Amplifying Alpha: Why Return Stacking Is the Next Big Thing in Investing
In the 1980s, a quiet revolution began in finance. Shortly after the launch of the first S&P 500 futures contract, PIMCO’s founder Bill Gross and Nobel laureate Myron Scholes discussed an ingenious idea: use cheap equity index futures to overlay stock market exposure on top of a bond portfolio. By doing so, PIMCO could deliver the benchmark returns (beta) of the S&P 500 plus the excess returns (alpha) from active bond management – effectively “porting” alpha from one asset onto another. The basic promise was compelling: why settle for just market returns when you can “stack” an extra layer of alpha on top?
What Is Portable Alpha (and Return Stacking)?
At its core, portable alpha is an investment approach that separates beta and alpha so they can be managed independently. Originally, portable alpha centered on extracting alpha from one asset class, such as an alternative like a long/short equity strategy, while gaining core market exposure in a separate asset class (commonly equity index futures or Treasury futures). This approach intrigued large institutions because it unlocked new ways to combine decorrelated strategies. If your alpha source didn’t move in tandem with your beta overlay, you could, in theory, enhance total returns and reduce overall risk through diversification. An investor can source alpha from one strategy and “port” it onto a different market beta that they wish to maintain (especially via derivatives). The result is a kind of “two-for-one” portfolio: your dollar of capital is simultaneously working to earn the market return and an extra layer of alpha on top.
Return stacking is essentially the “two engines” approach: keep a conventional allocation (e.g., 60/40) while layering an uncorrelated strategy over the same capital. For instance, an investor can invest $100 in a managed futures fund, then use a small portion of that fund’s margin to buy equity futures. This results in both equity beta and a diversifying alpha source. The combined portfolio can deliver a more favorable risk/return profile if the strategies truly zig and zag independently.
Below is a hypothetical illustration:
| Portfolio Component | Notional Exposure | Expected Alpha (Annual) | Correlation to Core |
|---|---|---|---|
| Core Equity + Bond Allocation | $100 | — | — |
| Managed Futures Overlay | $100 | +2–3% | Low to Negative |
| Stacked Portfolio | $200 gross | Potential +2–3% boost | Reduced Volatility |
If each engine is uncorrelated, returns can compound more efficiently. Importantly, when done thoughtfully with uncorrelated assets, stacking returns need not blow up risk; in fact, added leverage “can reduce risk, not increase it,” if the layered strategies zig and zag at different times. This is the crux of both portable alpha and return stacking: capital efficiency.
A False Start in the 2000s
By the early 2000s, sophisticated institutional investors were actively implementing “overlay programs,” combining hedge-fund-like alpha sources with synthetic beta through futures or swaps. At its peak, nearly a quarter of large U.S. public pension plans had portable alpha strategies, lured by the promise of enhanced returns without additional direct equity risk.
The Global Financial Crisis laid bare portable alpha’s vulnerabilities. Many programs relied on leverage and assumed ample liquidity in hedge funds or derivatives. When markets collapsed, some alpha strategies turned out to be more correlated to equities than expected, forcing investors into urgent margin calls just as hedge funds gated or suspended redemptions.
Resurgence Through Derivatives, ETFs, and Better Controls
Over the last decade, portable alpha has quietly evolved under the new moniker of “return stacking.” Though the concept remains essentially the same, by layering an uncorrelated alpha source atop existing beta, the tools and risk controls have improved considerably:
Derivatives & Collateral Efficiency
Modern return-stacking approaches increasingly rely on margining against stable collateral, such as Treasuries or short-term T-bills, when overlaying derivatives (e.g., equity index futures, options). Rather than tying up large sums in traditional equity or cash, this setup frees capital for alpha-generating strategies and offers clearer, more transparent exposure.Stricter Risk Management
Today’s managers typically maintain larger cash buffers and utilize real-time collateral monitoring to prevent a liquidity crunch if volatility spikes. Some go further by embedding explicit “de-lever triggers”, automatic measures that trim exposures or increase collateral requirements once volatility crosses certain thresholds.User-Friendly Implementation
Exchange-traded funds (ETFs) and mutual funds can now package multiple exposures, such as 100% equities plus 100% managed futures, into a single vehicle, simplifying execution. For retail investors and hedge funds alike, these products and overlays allow nimble adjustments to the portfolio’s risk profile without requiring a patchwork of complex swap agreements or multiple prime-broker relationships.Shifting Market Landscape
With higher interest rates, portfolios earn meaningful yield on collateral, offsetting the financing expenses that come with leverage. At the same time, persistently high equity valuations and lower long-term return forecasts have fueled demand for capital-efficient ways to seek outperformance
Although these portfolios differ in execution, the unifying theme is Markowitz’s free-lunch premise: mixing assets or strategies that don’t move together can yield higher risk-adjusted returns than any single component alone.
In essence, portable alpha didn’t fail because the idea was flawed; it stumbled when excessive leverage, hidden correlations, and lax liquidity controls converged during the 2008 crisis. The rebranded, modern-day approach is proving it can be done more safely. Institutions once burned by leveraged overlays are revisiting return stacking—mindful of past lessons but encouraged by better products, advanced margining, and the genuine diversification benefits that come with skill-based alpha.
Ultimately, portable alpha’s revival underlines a simple truth: when uncorrelated strategies are executed with prudence and transparent oversight, investors can layer new return streams over core market exposures without accepting outsized risk. These refinements have given portable alpha a second life, positioning it as a forward-looking strategy for those seeking higher risk-adjusted returns in today’s ever-evolving markets.
More Leverage = More Risk?
It’s understandable to view return stacking, or portable alpha, as merely adding leverage. Indeed, at first glance it might look like a way to double down on risk. Yet modern academic research and industry practice show otherwise. For instance, Andrew Ang’s Asset Management: A Systematic Approach to Factor Investing (2014) emphasizes that adding multiple uncorrelated strategies can reduce total portfolio volatility despite the use of derivatives. Similarly, CME Group whitepapers on overlay strategies illustrate how transparent collateral management, real-time monitoring, and properly structured margin buffers can prevent the liquidity squeezes that plagued some leveraged portfolios in 2008.
The key is true diversification. If each “engine” has a low correlation to the others, layering strategies can smooth overall returns. Studies have also shown that thoughtful use of futures overlays, while keeping beta and alpha exposures distinct, often lowers net drawdowns relative to a single, monolithic portfolio. The notion is that prudent, rules-based overlay programs can behave more like an insurance mechanism, kicking in returns when core assets might be lagging.
Moreover, modern return-stacking vehicles typically mandate “de-lever triggers” and active rebalancing, processes that reduce exposures or boost collateral when markets become turbulent. These measures, now standard in many institutional overlay programs, address the primary pitfall of past portable alpha strategies: hidden correlations and unchecked leverage. By investing in well-structured strategies, investors are not just multiplying risk but rather reallocating their risk budget toward genuinely independent return sources. When executed with liquidity discipline and risk oversight, return stacking can be a more robust way to pursue alpha, not simply a levered bet.
Stacking Orthogonal Strategies
At Rembrandt Capital, we embed a return-stacking philosophy in our quantitative strategies. Rather than rely on a single alpha source, we combine multiple orthogonal approaches over core exposures to traditional markets. The aim is to harness uncorrelated engines of return and to manage margin usage carefully so that each strategy can help offset potential drawdowns in another. Below is a chart highlighting the near-zero correlation (approximately 0.04) between equities and a group of quantitative strategies illustrating how truly independent return drivers can help temper overall volatility and preserve capital through varying market conditions.
Stacking is possible with Treasuries, equities, or a variety of quantitative strategies, as long as each “engine” remains uncorrelated. In historical backtests, two distinct strategy sets showed a correlation of just 0.15. By applying a 200% notional exposure, it becomes feasible to harness return stacking principles in pursuit of enhanced total returns without taking on excessive overall risk.
By porting alpha onto a chosen beta using capital-efficient overlays and ensuring proper liquidity buffers, investors may truly unlock the potential that originally captivated Bill Gross and Myron Scholes decades ago. The concept of “more engines, one portfolio” has stood the test of time, and in its new form, return stacking promises a powerful way to generate extra alpha for investors.