Uncorrelated Investing Is Ultimate Risk Reduction for Investors
By WPT Funds Management
Apr 23, 2019
Hedge Funds
Apr 23, 2019
This paper explores the value of low-statistical-dependence risk premia building blocks and their role in improving investment outcomes. Low statistical dependence is frequently underestimated both as a mechanism for controlling risk and as a potential source of additional return. While the underlying mathematics of volatility, correlation and portfolio outcomes are well established and relatively well known, it is frequently the case that investors lack a visceral intuition for just how powerful these statistical features are in contributing to desirable investment outcomes.
Example Pension Fund Allocation
U.S. Pension funds are some of the largest and most sophisticated investors in the world, we have chosen to complete a cross section analysis between an average 60/40 stock bond portfolio, the average pension fund according to a publication by JPMorgan, the typical U.S. public pension plan has approximately 52% of its assets in equities, 28% in fixed income, 5% in real estate and 14% in total alternatives (confusing, grammatically-incorrect sentence – please simplify and clarify what you’re trying to say and break down this sentence down into smaller pieces – Dave). In order to analyze the merits of this typical allocation, we have attempted to realistically design a proxy for it by selecting a broad collection of related indices as depicted in Exhibit 1 below. Based on a typical institutional asset allocation, the equity exposure was created with the following style and regional allocations: U.S. large cap (21%), U.S. small cap (5%), non-U.S. developed equities (21%) and emerging markets equity (5%). Likewise, the fixed income exposure was further broken down as follows: short-duration fixed income (3%), core fixed income (20%) and TIPS (5%). Due to a lack of an appropriate passive benchmark, the Russell 2000 Growth Index represented the private equity exposure with a quarterly lag.
Exhibit 1: Example Pension Fund Asset Allocation
The portfolio is hypothetical and used for illustrative purposes only.
