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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

Raul Leote de Carvalho

BNP Paribas Investment Partners

Lu Xiao

BNP Paribas Investment Partners

Pierre Moulin

BNP Paribas Investment Partners

Date Written: September 13, 2011

Abstract

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

Carvalho, Raul Leote de and Xiao, Lu and Moulin, Pierre, Demystifying Equity Risk-Based Strategies: A Simple Alpha Plus Beta Description (September 13, 2011). The Journal of Portfolio Management, vol. 38, no. 3, Spring 2012. . Available at SSRN: https://ssrn.com/abstract=1949003

Raul Leote de Carvalho (Contact Author)

BNP Paribas Investment Partners ( email )

Paris
France
0033158972183 (Phone)

Lu Xiao

BNP Paribas Investment Partners ( email )

14 rue bergère
Paris, 75009
France

Pierre Moulin

BNP Paribas Investment Partners ( email )

Paris
France

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