Investing across a combination of risk factors—or ‘styles’—rather than individual ones may deliver uncorrelated premia, deliver higher returns, and reduce risk, according to AQR.
In a paper, the hedge fund group argued that investors tend to focus on value, momentum, carry, and defensive factors separately, missing out on potential diversification benefits. The firm added investors are likely to overpay in costs and fees by chasing these alternative sources of return.
“Just as multi-strategy alternatives seek to benefit from diversification across strategies to provide investors more consistent outperformance, so can a combination of styles,” AQR said.
The firm applied the four styles across six different asset groups—ranging from stocks to currencies to commodities—during a set period from January 1990 to June 2013, and found positive risk-adjusted returns and low correlations to the equity market.
Sharpe ratios ranged from 0.9 to 1.3 while correlation to equities varied from -0.15 to 0.22. These factors also diversified one another, with cross-correlations from -0.6 to 0.22.
While certain pairings of factors and asset class may outperform others, AQR said a comprehensive combination of styles would be most efficient in building a “well-balanced, diversified portfolio.” It would also avoid “strategically over- or under-weighting certain styles,” the firm added.
According to the firm’s data, a multi-style composite portfolio was able to provide high risk-adjusted returns—a Sharpe ratio of 1.02—with just 0.01 of correlation to equities.
The correlation between the factor portfolio and a 60/40 portfolio from 1990 to 2013 was just 0.02 while its correlation to the Credit Suisse hedge fund index was higher at 0.16.
Adding composite factor exposure to the traditional portfolio also reduced volatility, from 9.5% in the 60/40 portfolio to 7.3% with 30% of style premia.
AQR launched its style premia alternative fund last year.