Journal of Investment Strategies

Risk.net

Equal risk allocation with carry, value and momentum

Boris Gnedenko and Igor Yelnik

  • We analyze an equal-weight portfolio of three global cross-asset class factors.
  • Empirically, this allocation largely replaces allocation to equity/bond premia.
  • This result holds if a hedge fund allocation is added to an equity/bond portfolio.
  • Our backtest is based on 3 decades of historical data and accounts for transaction costs.

ABSTRACT

In this paper, we analyze an equal-weight portfolio of global cross-asset-class risk factor exposures. Our main finding is that such risk factor allocation largely replaces traditional global equity and bond market premiums as well as allocation to hedge funds (in the expected utility maximization sense). Hence, we question the economic validity of the Alpha-Beta separation paradigm that currently prevails in the industry. We show that our results are robust to transaction costs. The empirical analysis is made for a global portfolio of three well-known risk factors: momentum, value and carry. Each risk factor is broadly diversified across four global asset classes and taken both in cross-sectional and time series contexts. We test our approach using thirty-eight years of daily historical prices in a broad set of futures contracts and major foreign exchange rates.

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