Ignorance is bliss: Applying risk management techniques from alternatives to long only investing

Graham Robertson and Russell Korgaonkar

Academic studies have shown that risk is more predictable than returns. Traditional “60/40” portfolios, however, focus on return expectations through the allocation of notional rather than risk. This chapter will illustrate that it is possible to build portfolios using tried and tested risk management techniques that have similar risk characteristics to traditional porfolios but improved returns.

Termed the “Z-shift” because of the figure drawn in risk/return space, we make use of diversification, capital efficiency and risk management overlays. The chapter is laid out to examine each of those facets in turn, concluding with an empirical evaluation of the technique. The simulated portfolio derived utilises highly liquid instruments across asset classes to facilitate highly active trading in response to potentially rapidly changing market environments.

The Z-shift framework is a complement to the role traditionally played by asset allocators. It liberates the allocator from decisions they are not good at, and allows them to spend more time on aspects of the portfolio where there is genuine value-add.

INTRODUCTION

Traditional asset management typically has a top-down