Demystifying Equity Risk-Based Strategies: A Simple Alpha Plus Beta Description
The Journal of Portfolio Management, vol. 38, no. 3, Spring 2012.
Posted: 25 Oct 2011 Last revised: 3 Feb 2015
Date Written: September 13, 2011
We considered five risk-based strategies: equally-weighted, equal-risk budget, equal-risk contribution, minimum variance and maximum diversification. All five can be well described by exposure to the market-cap index and to four simple factors: low-beta, small-cap, low-residual volatility and value. This is, in our view, a major contribution to the understanding of such strategies and provides a simple framework to compare them. All except equally-weighted are defensive with lower volatility than the market-cap index. Equally-weighted is exposed to small-cap stocks. Equal-risk budget and equal-risk contribution are exposed to small-cap and to low-beta stocks. These three have a high correlation of excess returns and their portfolio largely overlap. They invest in all stocks available and have both a low turnover and low tracking error relative to market-cap index. Minimum variance and maximum diversification are essentially exposed to low-beta stocks. They are the most defensive, invest in much the same stocks and have high tracking error and turnover.
Keywords: low volatility, risk-based, minimum variance, equally-weighted, equal-risk budget, equal-risk contribution, maximum diversification, portfolio construction
JEL Classification: G11
Suggested Citation: Suggested Citation