A 'Smart' Alpha Overlay

13 Pages Posted: 17 Sep 2015

Date Written: September 15, 2015

Abstract

The recent surge of interest in so-called smart beta strategies originates from the apparent shortcomings of both traditional benchmarks and active management. Yet not all investors want to follow passive indexing, no matter how smart. Recent literature has tried to reconcile the need for integrating active views in a given benchmark with the risk discipline of the smart beta approach. In particular, Medvedev (2015) has proposed a procedure of risk optimization based on qualitative views or rankings and a prior portfolio. The current article updates that procedure by making it simpler, more robust and thus better suited for real life applications. Our aim is to present an easily implemented rule that, given a benchmark and a set of views, yields a portfolio that dominates the benchmark both in risk and return. We provide an intuitive interpretation of this algorithm as a hedging procedure where risk budgets allocated to each active view are determined on the basis of their hedging capacity. We demonstrate the working of this algorithm using the Dow Jones Large Caps equity index as an illustration.

Keywords: asset allocation, portfolio construction, alpha overlay, active views, minimum risk, expected returns

JEL Classification: C60, D81, G11

Suggested Citation

Medvedev, Alexey and Michel, Thierry, A 'Smart' Alpha Overlay (September 15, 2015). Available at SSRN: https://ssrn.com/abstract=2660959 or http://dx.doi.org/10.2139/ssrn.2660959

Alexey Medvedev (Contact Author)

Lombard Odier & Cie ( email )

11 rue de la Corraterie
1211 Geneva 11
Switzerland

Thierry Michel

Lombard Odier & Cie ( email )

11 rue de la Corraterie
Geneva, 1211
Switzerland

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