Alternative risk premia: The alternative disruptors
How multi-asset, alternative risk premia strategies are disrupting the alternatives sector
- Alternative risk premia strategies offer powerful diversification potential in cost-efficient, liquid form
- Advances in product design and digital support of investment research are supporting the growth of new vehicles
- Some managers have introduced alternative risk premia ETFs
- The ARP approach is attracting interest globally
There are no new risk premia! All hail the new risk premia strategies!
In just the last few years, a cottage industry of boutique investment managers serving the most sophisticated large investors has mushroomed into a major new sector of the institutional asset management industry – alternative risk premia.
Strategies to systematically capture the risk premium inherent in numerous assets and strategies, both long and short, offer institutions the opportunity to diversify the sources of return and risk in their portfolios with greater precision than ever before – at costs far below the fees charged by alternative managers seeking to capture the same return sources through fundamental investment processes, that is, hedge funds.
These new strategies build on the practice of investing in factors such as growth, momentum or value, and the development of smart beta strategies that sought to deliver investors only the market-level return of an asset, but at a much lower price than traditional managers seeking to not only keep pace with the market, but add something extra – alpha.
The alternative risk premia movement supercharges the basic practice of capturing beta, expanding the range of returns available from premia-capture approaches beyond the boundaries of long-only investing to encompass more complex strategies involving long-short portfolios, currency and fixed-income trend trading, spread relationships and credit transactions.
These new investment approaches are made possible by the convergence of product design techniques that support the creation of highly-liquid vehicles with intellectual capital development practices that enable academics and investment professionals to come to a sharper understanding of the sources of asset returns. Alternative risk premia providers exploit those opportunities through investment vehicles that enable those returns to be harvested with precision.
Those characteristics pose a challenge to hedge funds, which typically pursue a variety of risk premia. More efficient and less expensive, alternative risk premia products are pressuring single-strategy funds to demonstrate what return they add above the beta for their respective strategy; in effect, alternative premia products are becoming the benchmark that hedge funds must beat, a radical shift from the cash-plus targets that many funds use.
But even as single-strategy funds are pressured, alternative premia are breathing new life into a sector only recently consigned to investment history – hedge funds of funds. The multi-manager community is starting to tap alternative risk premia products as the core of a re-invented core-satellite approach, stimulating more intensive research into potentially alpha-generating satellite managers.
Some believe the recent popularity of alternative risk premia products means the investment industry is on the cusp of a long-term innovation wave similar to the trend that took hold after academics confirmed the systematic nature of equity returns in the late 1960s and early 1970s (figure 1). That discovery spawned the passive investing and indexing paradigm, and some practitioners see a parallel in the identification of the systematic nature of numerous other risk premia in the current environment. They contend that a similar wave of creative disruption is underway, to marry the Schumpeterian concept of renewal and innovation with the digital-age notion that most businesses can be improved by the astute application of programming know-how and computer power.
“We’re seeing a major new asset class arising, one which is bound to have staying power, in our view,” says Lars Jaeger, head of alternative risk premia at GAM Systematic in Zurich. “We can already see similar growth and a similar trajectory as traditional risk premia in the 1990s and 2000s,” he adds. A pioneer of alternative beta strategies nearly 15 years ago, Jaeger says alternative premia investing is an idea whose time has come. “It’s about time that we provide investors with access to liquid forms of alternative returns which are systematic, which are cost-efficient, which are liquid and transparent,” he says. “That’s what institutional investors are looking for.”
Alternative risk premia providers have tapped a vein. The strategies they offer go a long way towards helping institutional investors diversify the sources of return in their portfolios cost-effectively, while reducing dependence on directionally-based investing approaches. Traditionally, institutional portfolios such as those managed by pension funds are long-biased, and the ability to generate positive returns is heavily dependent on asset values moving in only one direction – up.
Consultants see potential benefits from adding alternative premia strategies to a traditional portfolio. “We’re certainly seeing interest in those and using them in portfolios because they’re good diversifiers to traditional long market exposures,” says James Price, senior investment consultant with Willis Towers Watson’s manager research team. “Some of those strategies can do well when traditional markets are suffering.”
“For an asset owner comfortable using those hedge fund strategies, it makes the most sense to put those in alongside their traditional equity and fixed income allocation,” Price says. “It increases diversity to sell some of [the traditional allocation] and buy an alternative beta strategy the brings exposure to new strategies that are not directional, not reliant on markets going up to be profitable,” he adds. “That increases diversification and value for money.”
To concerns that alternative risk premia strategies are nothing more than old wine in new bottles, Jaeger replies diplomatically. “It is old wine in new bottles,” he admits. “We’re not discovering new risk premia in the markets, but we’re discovering something that hedge funds have been trading for decades, charging fees of 2-and-20,” he says. “So these bottles are much cheaper and much more transparent and much more liquid,” he chuckles. “It’s good wine, and people like it – and they’d like to just not pay $400 for it if they can get it for $40.”
Managers are taking several approaches to meeting the demand for alternative risk premia strategies. A common thread is defining terms and applying organisational schema that help clarify what various strategies can deliver.
At JP Morgan Asset Management (JPMAM), the Quantitative Beta Strategies (QBS) team is a group of 14 quantitative research analysts and portfolio managers responsible for developing a factor-based franchise in alternative and strategic beta that now manages about $6.1bn (€5.2bn). The QBS team also includes 13 technology specialists that adapt tools like artificial intelligence to the needs of specific strategies.
As with any fast-evolving industry, it’s important to keep terms clear. “When we say strategic beta, we’re referring to what some might call smart beta,” says Yazann Romahi, chief investment officer of the QBS team. Morningstar defines as strategic beta strategies that are essentially long-only factors, he notes, “and that is what we’ve stuck to. “Alternative beta,” he adds, “is long-short a factor, so when we discuss strategic versus alternative beta, it is largely a comparison of long-only versus long-short.”
A key aspect of the alternative risk premia business is the ability to systematically deliver specific results. “Essentially it’s a quantitatively-driven process, as opposed to a fundamental process with a discretionary element,” Romahi says. “A value manager may have discretion over what is classified as a value stock, whereas if we are building a smart, strategic piece of equity strategy, the value stocks are all driven by the quantitative, systematic ranking of those stocks.”
JPMAM launched the $2.5bn Systematic Alpha fund in 2009, a multi-strategy portfolio that captures a number of hedge fund styles in three broad styles encompassing event-driven, which includes convertible bond arbitrage, equity market neutral, and macro and managed futures. The strategy seeks to equal risk-weight the three styles over the long-term, but alters allocations in the short-term contingent on available opportunities the strength of underlying signals.
A Diversified Risk strategy launched in 2013 uses a risk parity framework to construct a portfolio of long-short exposures to factors including value, quality, momentum and carry, across different asset classes. In autumn 2017, JPMAM launched exchange-traded funds offering equity long-short and managed futures strategies designed and managed by the QBS team, the first European provider to roll out ETF vehicles designed to capture premia usually targeted by hedge funds. The ETFs will have maximum total expense ratios of only 67 and 57bps, respectively.
The QBS team opts for digital innovation wherever possible. Its NewsFilter, for example, uses artificial intelligence to power natural-language screening of Bloomerg News to highlight events that appear to be news of potential rumours of mergers; the equity long-short strategy seeks to avoid shorting stocks that may be subject to deal rumours that could move a stock’s price for idiosyncratic reasons rather than purely their factor exposure. “The filter helps remove idiosyncratic risk and therefore capture the factors in a more efficient fashion,” Romahi says.
The systematic approach at GAM organises approximately 15 to 20 general risk premia into three styles, value, momentum and carry. These are applied across equity, currencies, fixed income and commodities. “This gives you a matrix you can adapt to client situations,” says Jaeger. “There are many different types of alternative risk premia, and since there is a broad set the diversification potential is tremendous.”
GAM Systematic delivers its alternative risk premia expertise in several formats. Those include a series of pooled funds, one in UCITS format, as well as Cayman Islands-based funds, and an Australian dollar fund for investors there. In most scenarios, funds are managing global portfolios, diversified over the entire spectrum of risk premia (figure 2). “That’s what most investors are looking for,” Jaeger says. But GAM also provide access to individual risk premia in situation where clients want to fill one bucket with a GAM strategy and another bucket with a different provider, or when a client wants a specific mandate filled. “We’re quite flexible,” says Jaeger. “It’s a nice toolbox that we offer, but most investors still are looking at the entire set, not just individual strategies.”
The bottom line on the attraction of alternative risk premia products to investors today is, well, the bottom line. A ticket on the hedge fund train has become too dear for institutions striving to reduce management fees. “That’s why they’re jumping off,” says Jaeger. “Investors have woken up to the fact that hedge fund returns are mostly beta, and they can access those returns much more cost-efficiently through ARP providers.”
Institutional clients like the new approach. Says Jaeger: “I just came back from Australia where there’s huge demand for risk premia from superannuation funds. In the US, it’s the same thing. We see it in Europe. We see it in Scandinavia. Less so in the UK, but it’s starting there. It’s a fascinating field. Having been in there for 13 years, and being seen as a pioneer of it, I’m thrilled.”