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Abstract
Does diversification using a basket of the most common alternative investments outperform diversification using low-cost, liquid risk premia? Investment banks have recently begun offering access to such risk premia at low cost. First, the authors confirm that alternative assets may reduce portfolio risk, based on historical experience. Second, they compare the risk-reduction benefits of alternative investments and risk premium portfolios out of sample, using equally weighted and least-risk optimized portfolios. They find that risk premia diversify more efficiently than do alternative asset portfolios. The authors suggest that an optimal portfolio combines the benefits of both risk premium and alternative asset portfolios, as some alternative assets (such as timber or managed futures) continue to provide exposure to unique sources of return.
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