Alternative Investing

The Alpha in Portfolio Construction

Topics - Alternative Investing Portfolio Construction

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The Alpha in Portfolio Construction

Investments and Pensions Europe

We believe that portfolio construction, risk management and cost control are the “low-hanging fruit” of managing a long-term portfolio. We contend that the skillful combination and management of the various components of the portfolio constitute a form of alpha on its own — this is what we call alpha through portfolio construction.

 Here are some specific suggestions for improving a portfolio:

  • Allocate by risk, not dollars. Measuring portfolio shares by dollar allocations can mislead. The 60/40 dollar split between stocks and bonds may sound balanced but actually is roughly a 90/10 risk allocation, given the greater risk of equities.
  • Ensure you are building a truly diversified portfolio. Investing in alternative portfolios that are highly correlated with the equity market only provides the illusion of diversification. Aim to assemble a portfolio of assets with high Sharpe ratios and attractive diversification abilities.
  • To generate returns comparable to equities-heavy strategies, diversification almost certainly requires the prudent use of leverage, short-selling and derivatives. Such tools involve financial risks to consider, but these risks have proven to be manageable even through some vicious downturns.
  • It is essential to not pay alpha prices for what is not alpha. The prospect of a prolonged period of low returns underscores the importance of cost-effectiveness, whatever returns investors are harvesting. Fair fees depend on the return source.

We also recommend that investors create a drawdown-control methodology for their overall portfolios — in short, a plan to systematically reduce risk because of losses and to add it back in a similarly systematic way as markets turn back up.


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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.


AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.