Demystifying Equity Risk–Based Strategies:A Simple Alpha plus Beta Description

Abstract

We considered five risk-based strategies: equally-weighted, equal-risk budget, equal-risk contribution, minimum variance and maximum diversification. All five can be well described by exposure to the market-cap index and to four simple factors: low-beta, small-cap, low-residual volatility and value. This is, in our view, a major contribution to the understanding of such strategies and provides a simple framework to compare them. All except equally-weighted are defensive with lower volatility than the market-cap index. Equally-weighted is exposed to small-cap stocks. Equal-risk budget and equal-risk contribution are exposed to small-cap and to low-beta stocks. These three have a high correlation of excess returns and their portfolio largely overlap. They invest in all stocks available and have both a low turnover and low tracking error relative to market-cap index. Minimum variance and maximum diversification are essentially exposed to low-beta stocks. They are the most defensive, invest in much the same stocks and have high tracking error and turnover.