Practical Applications of Performance Dispersion Risk Assessment in Alternatives and Active Strategies

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Practical Applications In Performance Dispersion Risk Assessment in Alternatives and Active Strategies from the Spring 2020 issue of The Journal of Alternative Investments, author Amit Soni of New York Life Investments addresses the fact that traditional portfolio optimization models underestimate the risk of investing in alternative asset classes, and therefore overallocate assets to them. They do this in part by ignoring the fact that individual alternative funds are more likely than traditional funds to perform much better or worse than average—a phenomenon called performance dispersion risk. Portfolio managers need a way to measure this type of risk, and the author provides one by using the cross-sectional volatility of the performance of all the managers in a particular investment category. He then provides a simple approach that utilizes the interquartile or interdecile performance range to approximate the cross-sectional volatility. He measures the relative performance dispersion risk of alternative funds by comparing it to the performance dispersion of traditional funds like US large-cap equities. The author finds that including such data in portfolio modeling calculations yields portfolios that are better balanced between alternative and traditional investments. This is likely to improve investor satisfaction. TOPICS:Real assets/alternative investments/private equity, statistical methods, performance measurement