Refining portfolio construction when alphas and risk factors are misaligned

In this research insight MSCI Barra explores the mitigation of misaligned risk and alpha factors by modifying the optimisation process. Firstly it reviews how to decompose a set of alphas into two components – one that is related to risk model factors, and one that is not. Then it shows how penalising the residual alpha in portfolio optimisation may improve a portfolio’s exposures and ex-ante information ratio.


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