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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A pension fund wants to exploit the low-risk anomaly but worries that a minimum-volatility equity portfolio has unintended exposures. Which is the most commonly cited risk of such a strategy?

Low-volatility portfolios are typically concentrated in defensive, bond-like sectors such as utilities and consumer staples, so they can be hurt by rising interest rates and tend to lag in strong market rallies, creating unintended sector and rate exposures.

  1. AIt tends to be heavily concentrated in defensive sectors and may suffer when interest rates rise or in strong market ralliesCorrect
  2. BIt has beta well above 1 and loses most in market downturns
  3. CIt is guaranteed to outperform in every market regime
  4. DIt holds mostly small, high-growth, high-leverage firms

Explanation

Low-volatility portfolios tilt to utilities, staples and similar sectors, behaving like bond proxies and exposing the fund to rate rises and lagging in sharp rallies. The other options contradict their typical low-beta, defensive profile.

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