Risk Without Return

TL;DR

This paper examines risk-only investment strategies, highlighting their underlying unity, the impact of transaction costs, and the relationship between risk diversification and performance, while introducing a new index for measuring risk concentration.

Contribution

It introduces the Risk Diversification Index (RDI) to measure risk concentrations and analyzes the effects of risk strategies on diversification and returns.

Findings

Risk-based strategies are manifestations of a single underlying effect.

Transaction costs significantly reduce net returns.

Risk diversification is linked to performance outcomes.

Abstract

Risk-only investment strategies have been growing in popularity as traditional in- vestment strategies have fallen short of return targets over the last decade. However, risk-based investors should be aware of four things. First, theoretical considerations and empirical studies show that apparently dictinct risk-based investment strategies are manifestations of a single effect. Second, turnover and associated transaction costs can be a substantial drag on return. Third, capital diversification benefits may be reduced. Fourth, there is an apparent connection between performance and risk diversification. To analyze risk diversification benefits in a consistent way, we introduce the Risk Diversification Index (RDI) which measures risk concentrations and complements the Herfindahl-Herschman Index (HHI) for capital concentrations.