Portfolio Construction

Alpha Beyond Expected Returns

Topics - Portfolio Construction Portfolio Risk and Performance

Read Time - 20 mins

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Alpha Beyond Expected Returns

Many institutional investors focus primarily on one source of alpha: expected returns, perhaps relative to a benchmark. There are many drawbacks to this approach, including manager search costs, limited performance persistence and (potentially) high fees. We argue that “alpha” can be more reliably captured in virtually every other stage of the investment process. In this paper, we suggest seven sources of value-added beyond the traditional view of “alpha,” grouped under three themes:

  • Portfolio Construction — diversification, that only “free lunch,” can be applied in aggressive and innovative ways
  • Risk Management — practices that generate a smoother ride enable investors to stick to their game plan in bad times
  • Cost Control — cost-effective execution and fair fees gain importance in a world of low expected returns. Our ideal portfolios aggressively exploit breadth; this almost always improves risk-adjusted returns.

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Alternative Investment Analyst Review

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

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