Risk allocation versus asset allocation - Improving the optimal allocation between risk and return.

Most investors are exposed to both systematic and active risks in their portfolios. Systematic risks stem from consistent exposure to marketwide factors, and are usually associated with marketwide risk premiums. Active risk comes from actively managing underlying security and/or systematic risk exposures. Traditional long-only investment strategies are usually dominated by systematic risk, while alternative investment strategies typically have more active risk than systematic risk. A risk allocation framework that explicitly differentiates between these two sources of risk enables investors to improve the risk/return profile of their portfolios. Such a framework also enables investors to better incorporate non-traditional or alternative investment strategies into portfolios by characterizing them in terms of their systematic and active risk rather than thinking of them as a separate asset class.