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

A risk manager is asked why a minimum-variance equity strategy that delivers low volatility may nevertheless carry risks relative to a cap-weighted benchmark. Which is the most appropriate concern?

Low-volatility strategies typically concentrate in defensive sectors, are sensitive to interest rates, and lag in strong speculative rallies. They have sizable tracking error and beta below one, so their lower volatility does not mean absence of relative risk.

  1. AIt tends to have concentrated sector tilts and interest-rate sensitivity, and can underperform sharply in strong, speculative bull marketsCorrect
  2. BIt always has a higher beta than the benchmark
  3. CIt has no tracking error relative to the benchmark
  4. DIt eliminates all factor exposures except market beta

Explanation

Low-risk portfolios often overweight utilities and staples, giving sector concentration and bond-like rate sensitivity, and they lag in high-beta rallies. Their beta is below one, tracking error is substantial, and they carry other factor exposures such as value or quality.

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