Stocks and bonds? Real estate? Hedge funds? Private equity? The conventional way of allocating across asset classes fails to account for the overlapping risks that they represent. Investors must consider the underlying factor risks behind asset class labels, just as eating a healthy diet requires looking through foods to the nutrients that they contain. Factor risks are the hard times that affect all assets, and investors are rewarded for weathering losses during bad times with long-run risk premiums. Optimally harvesting factor risk premiums—on our own or by hiring others—requires identifying our particular set of bad times and exploiting the difference between them and those of the average investor.
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