Risk allocation strategies applied to alternative risk factors could be more relevant than hedge fund replication for harvesting alternative risk premia

Written on 21 June 2016.


There is a growing interest amongst sophisticated institutional investors in factor investing. It is now well accepted that the average long-term performance of active mutual fund managers can, to a large extent, be replicated through a static exposure to traditional factors, which implies that traditional long-only risk premia can be most efficiently harvested in a passive manner.

By looking beyond traditional factors, this research does indeed identify other strategies that serve to harvest alternative risk premia. While the replication of hedge fund factor exposure appears to be a very attractive concept, the authors find that hedge fund replication strategies achieve in general a relatively low out-of-sample explanatory power, regardless of the set of factors and the methodologies used. Their results also suggest that risk parity strategies applied to alternative risk factors could be a better alternative than hedge fund replication for harvesting alternative risk premia in an efficient way.

A key challenge for the alternative investment industry remains the capacity to develop investable efficient low-cost proxies for harvesting alternative risk premia not only in equity markets but also in the fixed income, currencies and commodity markets.

Commenting on this study, Thierry Roncalli, Head of Research & Development at Lyxor Asset Management, said: “The results of EDHEC-Risk Institute question the role of alternative risk premia in a low or negative interest rate environment. We already knew them as diversification assets, but this study shows that they are potential candidates as performance assets. Therefore, this research opens a door for reconsidering the traditional equity/bond asset mix policy.”

A copy of “Factor Investing and Risk Allocation: From Traditional to Alternative Risk Premia Harvesting” can be downloaded via the following link:

EDHEC Publication Factor Investing and Risk Allocation: From Traditional to Alternative Risk Premia Harvesting

This research was supported by Lyxor Asset Management as part of the research chair at EDHEC-Risk Institute on “Risk Allocations Solutions”. This chair aims to develop academic insights that can be used towards the design of high-performance multi-asset investment solutions, based on specific investor needs.

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