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Fact and Fiction about Low-Risk Investing

Ron Alquist, Andrea Frazzini, Antti Ilmanen and Lasse Heje Pedersen
The Journal of Portfolio Management Multi-Asset Special Issue 2020, jpm.2020.1.146; DOI: https://doi.org/10.3905/jpm.2020.1.146
Ron Alquist
is a vice president at AQR Capital Management in Greenwich, CT
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Andrea Frazzini
is a principal at AQR Capital Management in Greenwich, CT
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Antti Ilmanen
is a principal at AQR Capital Management in Greenwich, CT
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Lasse Heje Pedersen
is a principal at AQR Capital Management in Greenwich, CT, and a professor at Copenhagen Business School in Copenhagen, Denmark
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Abstract

Low-risk investing within equities and other asset classes has received a lot of attention over the past decade. An intensive academic debate has spurred, and been spurred by, the growing market for low-risk strategies. This article presents five facts and dispels five fictions about low-risk investing. The facts are as follows: Low-risk returns have been (1) strong historically, (2) highly significant out of sample, (3) robust across many countries and asset classes, and (4) backed by strong economic theory but, nevertheless, (5) can be negative when the market is down. The fictions this article dispels are that low-risk investing (1) delivers weaker returns than other common factor premiums, (2) is mostly about betting on bond-like industries, (3) is especially sensitive to transaction costs and only works among small-cap stocks, and (4) has become so expensive that it cannot do well going forward. Lastly, the article dispels the fiction that (5) the capital asset pricing model (CAPM) is dead and so is low-risk investing—this statement is a contradiction. If the CAPM is dead, then low-risk investing is alive.

TOPICS: Factor-based models, style investing, volatility measures

Key Findings

  • • Low-risk investing has historically delivered significant risk-adjusted returns, both in sample and out of sample.

  • • Low-risk investing can be applied across asset classes, with strong returns in equities, government bonds, credit markets, and beyond.

  • • Low-risk investing can be applied based on statistical risk measures (e.g., beta) or fundamental risk measures (e.g., stable profits).

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The Journal of Portfolio Management: 49 (3)
The Journal of Portfolio Management
Vol. 49, Issue 3
February 2023
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Fact and Fiction about Low-Risk Investing
Ron Alquist, Andrea Frazzini, Antti Ilmanen, Lasse Heje Pedersen
The Journal of Portfolio Management Mar 2020, jpm.2020.1.146; DOI: 10.3905/jpm.2020.1.146

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Fact and Fiction about Low-Risk Investing
Ron Alquist, Andrea Frazzini, Antti Ilmanen, Lasse Heje Pedersen
The Journal of Portfolio Management Mar 2020, jpm.2020.1.146; DOI: 10.3905/jpm.2020.1.146
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  • Article
    • Abstract
    • DATA AND METHODOLOGY
    • LOW-RISK ASSETS OUTPERFORM HIGH-RISK ASSETS ON A RISK-ADJUSTED BASIS (FACT)
    • BUT THE LOW-RISK RETURN PREMIUM IS WEAKER THAN OTHER COMMON FACTOR PREMIUMS (FICTION)
    • THE LOW-RISK PREMIUM IS SIGNIFICANT OUT OF SAMPLE (FACT)
    • LOW-RISK INVESTING IS MOSTLY ABOUT INDUSTRY BETS, BETTING ON BOND-LIKE INDUSTRIES (FICTION)
    • LOW-RISK INVESTING IS ROBUST ACROSS MANY COUNTRIES AND ASSET CLASSES (FACT)
    • THE CAPM IS DEAD AND SO IS LOW-RISK INVESTING (FICTION)
    • ALTHOUGH A REJECTION OF THE CAPM, ECONOMIC THEORY UNDERLIES THE LOW-RISK PREMIUM (FACT)
    • LOW-RISK INVESTING IS ESPECIALLY SENSITIVE TO TRANSACTION COSTS AND ONLY WORKS AMONG SMALL-CAP STOCKS (FICTION)
    • LOW-RISK INVESTING CAN LOSE MONEY WHEN THE MARKET IS DOWN (FACT)
    • LOW-RISK STRATEGIES HAVE BECOME SO EXPENSIVE THAT THEY CANNOT DO WELL GOING FORWARD (FICTION)
    • CONCLUSION
    • ADDITIONAL READING
    • ACKNOWLEDGMENTS
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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