Equal risk allocation with carry, value and momentum

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.