Multi-Alpha Equity Portfolios: An Integrated Risk Budgeting Approach for Robust Constrained Portfolios
Forthcoming Journal of Asset Management
34 Pages Posted: 10 Nov 2012 Last revised: 29 Jun 2014
Date Written: October 24, 2012
We propose a robust optimization approach to construct realistic constrained multi-strategy portfolios which starts with the identification of different sources of alpha and the risk-budgeting exercise to optimally combine them. We show how systematic alpha-capture strategies can be combined with judgmental strategies and how bottom-up based strategies for stock picking can be combined with top-down sector and country allocation strategies. The approach is shown to be fully transparent for both unconstrained and constrained portfolios with a discussion of how constraints impact the final optimal portfolio allocation. In particular we show that the constrained portfolios retain the exposures to systematic risk in the unconstrained target solution as much as possible, and that specific risk takes the toll of portfolio constraints. Through a realistic back-tested example combining different well-known alpha capture strategies we demonstrate the robustness and transparency of the approach. Finally we also discuss the advantages of this approach over the alternative process based on selecting and investing in a mix of different index-funds implementing off-the-shelf active strategies for alpha capture. We believe that our approach is particularly suited for institutional investors interested in risk budgeting the alpha in their portfolios while fully understanding the final allocation in their constrained portfolios.
Keywords: robust optimization, risk budgeting, alpha, smart-beta, beta premia, portfolio construction, black-litterman, index funds, active management
JEL Classification: G11
Suggested Citation: Suggested Citation