In the white paper, A Better Approach to Alternative Investing, AQR Capital Management argued that despite many investors remaining cautious about the asset class, liquid multi-strategy alternative funds “should form the core of most investor’s alternatives allocation”.
“Investor caution is … understandable, as the rules for investing in alternatives are less well-known than for their traditional counterparts,” AQR said in the white paper.
“However, not all alternatives are created equal,” it said.
In order to create an alternative strategy that can provide attractive returns, AQR recommends investors seek low correlations to traditional assets to reduce volatility and increase long-term returns.
AQR said one way to achieve low correlation is to focus on strategies that take advantage of mispricing between similar assets.
In addition, AQR recommends investors look to diversify broadly across different strategies and to diversify by risk, not capital.
“Adding more strategies … does not guarantee a more diversified portfolio because diversification depends on correlation,” AQR said.
“However, if the strategies being considered are uncorrelated to each other, including more of them can generally improve the portfolios risk-adjusted returns.
“Allocating by market cap does diversify the overall portfolios, but allocating by risk leads to meaningfully higher risk-adjusted returns. Why? Even the best-performing individual strategies can realise substantial short-term drawdowns and go through extended periods of anaemic returns.”
AQR said that with an increase in more liquid and transparent options in the market, interest in alternatives is likely to continue.
“Institutional investors have long embraced alternative strategies, whose long-term efficacy and effective diversification add significant value,” AQR said.
“We are optimistic that a wider range of investors will be able to access these valuable tools for enhancing portfolio returns.”
