Practical Applications of The Tortoise and the Hare: Risk Premium versus Alternative Asset Portfolios

Abstract

While alternative investments reduce portfolio risk, implementing risk premia strategies using liquid futures, ETFs and/or other low-cost products can offer superior diversification. The authors of this research compare the risk-reduction benefits of alternative investments and risk premia strategies.

In The Tortoise and the Hare: Risk Premium versus Alternative Asset Portfolios , co-authors Ron Bird , Harry Liem and Susan Thorp (from the research team at the Paul Woolley Centre at the University of Technology, Sydney) examine whether risk premia (the tortoise) actually offer improved diversification benefits versus alternative investments (the hare), using equal-weighted and least-risk-optimized portfolios.

“We know that alternative investments are a hot product for institutional investors,… but are they as good as a lot of people would have us believe?” asks Bird.

The analysis shows the tortoise has the advantage. The study constructs efficient frontiers for the two types of portfolios and finds that, overall, risk premia portfolios outperformed pure alternative investments. Some risk-premia strategies generate lower returns, but with much lower standard deviations, offering higher Sharpe ratios in most cases.

TOPICS: Portfolio theory, analysis of individual factors/risk premia, tail risks