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There is a growing interest amongst sophisticated institutional investors in factor investing. It is now well accepted that the average long-term performance of active mutual fund managers can, to a large extent, be replicated through a static exposure to traditional factors, which implies that traditional long-only risk premia can be most efficiently harvested in a passive manner.
While the replication of hedge fund factor exposure appears to be a very attractive concept, we find that hedge fund replication strategies achieve in general a relatively low out-of-sample explanatory power, regardless of the set of factors and the methodologies used. Our results also suggest that risk parity strategies applied to alternative risk factors could be a better alternative than hedge fund replication for harvesting alternative risk premia in an efficient way.
A key challenge for the alternative investment industry remains the capacity to develop investable efficient low-cost proxies for harvesting alternative risk premia not only in equity markets but also in the fixed income, currencies and commodity markets.