Alternative Risk Premia – a panacea for difficult times?

CAMRADATA, a leading provider of data and analysis for institutional investors has published a new whitepaper, ‘Alternative Risk Premia – A panacea for difficult times?’ aimed at investors considering ARP strategies.

The whitepaper was written following CAMRADATA’s September roundtable event, where a panel of ARP managers, investment consultants and asset owners were invited to discuss the investment potential for ARPs.

They discussed the rising popularity of ARPs and whether they provide diversification and could allow for effective portfolio construction, a key component to delivering alternative sources of return.

They also looked at key questions posed by investors considering ARP strategies such as: Which strategies should I allocate to? How important is strategy design and implementation? How do I ensure appropriate risk management? What diversification properties do they bring to a portfolio?

Sean Thompson, Managing Director, CAMRADATA said, “Alternative Risk Premia (ARP) is of growing interest to pension funds and insurers as they search for strategies that can earn them a return without excessive risk.

“ARP is gaining popularity as a stand-alone investment because portfolios combining multiple alternative risk premia are among the few investment options that not only offer high return potential, but also meaningful portfolio diversification. Generally lower fees and better liquidity terms than traditional hedge funds also add to their appeal. Given this space is still rapidly evolving; we looked at where these strategies fit into overall asset allocation and what role they play.”

Key findings in the White Paper

The panellists at the roundtable agreed that Alternative Risk Premia (ARP) strategies are winning business from insurers, pension funds and their consultants.

London-based adviser, Redington has directed £1.5bn towards ARP over the last 12 months, according to Nick Samuels, who heads up research into liquid strategies at Redington. This followed a major review into 40 ARP strategies.

Asset managers are equally busy. Unigestion, already well known for its Low-Volatility equity strategies, has conducted 36 meetings on ARPs in the last three months.

Quoniam Asset Management continues to see strong interest across the market with pension schemes and insurance companies looking to allocate given the diversification benefits (zero correlation to traditional asset classes) and inherent cost effectiveness.

Lombard Odier Investment Management (LOIM) is on the brink of a major mandate in from Asia and has received several enquiries from the US – even though it is not a household name there.

Although ARP strategies are trending, they are not yet familiar to all. For some, they introduce another acronym and more jargon to lay decision-makers at pensions so one of the first points on the agenda was to define ARPs.

Trudi Boardman, a hedge fund specialist at advisory firm, Cambridge Associates suggested they are “extremely well marketed liquid diversifying strategies.”

Joan Lee, an investment manager in Unigestion’s cross-assets team described them as, “Systematic long/short strategies that provide well known structural opportunities in low-cost liquid format.”

These two definitions elucidate that while these strategies deal in alternatives of some kind, they are not like infrastructure or private equity that requires locking up commitments for years. On the contrary, ARP strategies typically have daily dealing and invest in the most liquid kind of derivative contracts – on major securities indexes.

The power of diversification is hinted at by Joan Lee’s mention of “long-short”. ARP strategies may exploit the most readily tradeable index derivatives but they are not merely relying on buying them in varying quantities: they are shorting as well. Overall, multi-ARP strategies aim to limit exposure to traditional assets by taking both long and short positions.

The panel highlighted ARPs have moved on significantly from fifteen years ago when only proprietary trading desks of some investment banks and hedge funds were exploiting such techniques on behalf of their clients. Now they are moving towards the mainstream and systematised by ARP providers such as Quoniam, LOIM and Unigestion.

All three asset managers at the roundtable acknowledged the systematic nature of their strategies. That means all three are highly quantitative, with intervention or ‘override’ only in the event of extreme situations. However, the panellists suggested that the appeal of quantitative strategies for investors comes and goes over time.

Nick Samuels at Redington says that some trustees can feel uncomfortable when they learn there is not a portfolio manager making decisions daily. On the other hand, part of the appeal of ARPs is that because they are systematic, they are much cheaper than hedge funds.

This attracts investors who accept that there are persistent sources of return in financial markets and understand that models for portfolio construction and algorithms for trading can harvest those returns better than the endeavours of a “hero” portfolio manager or team.

The panellists concluded that ARP are a viable diversifier because they rely on a variety of well-established sources of return. Accessing risk premia from commodities, fixed income, foreign exchange and equities while avoiding most of the beta of these asset classes increases their appeal alongside traditional long-only strategies.

They highlighted too that one of the biggest dilemmas for prospective clients may be the issue of which ARP manager to select. In a trending sector, there are many me-too products that need to be bypassed to find managers with a genuinely sustainable methodology for earning target returns – typically cash + 5-7% – into the future.

Sean Thompson, Managing Director, CAMRADATA adds, “Careful construction of exposures and an active approach to the risk management of ARP strategies is critical. One must look past the labels and study their drivers and return profiles during portfolio construction. Our whitepaper will give investors expert insights into this relatively new investment strategy to help plan their portfolios.”

Click here to download the Whitepaper.