Diversification at a Reasonable Price: Revisiting Alternative Diversification from an Institutional Investor’s Perspective

Abstract

The search for yield in a risk-conscious world is open. We therefore emphasize in this
article on the necessity for investors facing liability constraints to address the risk
and the return dimensions concomitantly. We introduce in this respect the Diversification-
at-a-Reasonable Price approach, and investigate the benefits of a wide
set of Alternative Investment Strategies. Against conventional wisdom, we find that
“illiquid” (e.g., Private Equity, Infrastructure) and “alternative” (e.g., Hedge Funds)
Alternative Investment Strategies do not necessarily dominate “traditional” ones (e.g.,
Small Caps, High Yield). Very interestingly, the results obtained in our empirical analysis
suggest that Institutional Investors could dramatically increase their exposure to
carefully selected Alternative Investment Strategies even with a very limited Tracking
Error budget. This is a very good omen for these Alternative Investment Strategies
(e.g., CTAs, Merger Arb.).