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Portfolio of Risk Premia: A New Approach to Diversification

13 Pages Posted: 24 Jan 2009  

Remy Briand

MSCI Barra

Frank Nielsen

MSCI Inc.

Dan Stefek

MSCI Inc.

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Date Written: January, 21 2009

Abstract

Traditional approaches of structuring policy portfolios for strategic asset allocation have not provided the full potential of diversification. Portfolios based upon a 60/40 allocation between equities and bonds remain volatile and dominated by equity risk. In this paper, we introduce a different approach to portfolio diversification. This approach looks at structuring portfolios using available risk premia within the traditional asset classes or from systematic trading strategies rather than focusing on classic betas such as equities and bonds. We start by reviewing the various ways of dissecting asset classes into their underlying systematic drivers or risk premia and analyze the historical risk and return patterns for a number of risk premia across asset classes. In a second stage, we illustrate empirically that correlations between risk premia have been low, offering significant diversification potential. We then confirm the benefits of diversification with a simple asset allocation case study by comparing a typical 60/40 equity/fixed income allocation with an equal weighted allocation across eleven style and strategy risk premia. From 1995 to 2008, this simple combination had returns similar to the traditional allocation but with 65% less volatility.

Keywords: Asset Allocation, Diversification, Risk Premia

Suggested Citation

Briand, Remy and Nielsen, Frank and Stefek, Dan, Portfolio of Risk Premia: A New Approach to Diversification (January, 21 2009). MSCI Barra Research Paper No. 2009-01. Available at SSRN: https://ssrn.com/abstract=1331080 or http://dx.doi.org/10.2139/ssrn.1331080

Remy Briand (Contact Author)

MSCI Barra ( email )

8 Rue de la Confederation
Geneva, 1204
Switzerland
+41 22 817 9303 (Phone)

Frank Nielsen

MSCI Inc. ( email )

88 Pine Street
2nd Floor
New York, NY 10005
United States

Dan Stefek

MSCI Inc. ( email )

88 Pine Street
2nd Floor
New York, NY 10005
United States

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