21 June 2016

EDHEC: Factor investing and risk allocation: from traditional to alternative risk premia harvesting

This study extends the analysis of factor investing beyond traditional factors and seeks to investigate what the best possible approach is for harvesting alternative long short-risk premia.

There is a growing interest amongst sophisticated institutional investors in factor investing. It is now well accepted that the average long-term performance of active mutual fund managers can, to a large extent, be replicated through a static exposure to traditional factors, which implies that traditional long-only risk premia can be most efficiently harvested in a passive manner.

While the replication of hedge fund factor exposure appears to be a very attractive concept, we find that hedge fund replication strategies achieve in general a relatively low out-of-sample explanatory power, regardless of the set of factors and the methodologies used. Our results also suggest that risk parity strategies applied to alternative risk factors could be a better alternative than hedge fund replication for harvesting alternative risk premia in an efficient way.

A key challenge for the alternative investment industry remains the capacity to develop investable efficient low-cost proxies for harvesting alternative risk premia not only in equity markets but also in the fixed income, currencies and commodity markets.

Full study

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