Investment in the new, fast growing asset class of ‘Alternative Risk Premia’ (ARP) funds has delivered institutional investors better risk adjusted returns and more capital protection, suggests new research from Cambridge Associates, the global investment firm.
ARPs are often added to a traditional portfolio (eg equities and bonds) to diversify returns and lower risk, which is particularly important now that traditional asset prices are seen as stretched.
Cambridge Associates says that its research shows a balanced portfolio with a 30 per cent exposure to ARP funds would have returned 12 per cent to investors between January 2007 and March 2009 (during the credit crunch), compared to just 3 per cent for a traditional balanced portfolio of bonds and equities.
Their research also shows that a balanced portfolio diversified with ARP funds would have grown by 65 per cent between September 2012 and December 2017 compared to an average of 51.5 per cent across a range of other common techniques for diversifying a portfolio, such as adding a safe haven currency.
Cambridge Associates’ research covers USD73 billion of assets in 33 ARP funds.
ARP funds look to exploit persistent trends, often identified by multiple academic studies, that create biases in asset prices and, therefore, excess returns. These can include, for example, currency “carry trades” that generate returns by holding a higher yielding currency whilst borrowing in a low yielding currency.
As these fund strategies should be unconnected to broader market movements in equities or bonds they should deliver diversification and resilience in times of a sharp market sell-off.
Other ARP strategies might include: value investing – long under-valued equities and short over-valued equities; and momentum: investments that have outperformed recently tend to continue to outperform.
ARP funds are also popular as their relatively straightforward strategies mean fees typically range between 0.75 per cent and 1 per cent. This can seem very competitive compared to the traditional ‘2 and 20’ of the hedge fund industry.
Tomas Kmetko, Senior Investment Director at Cambridge Associates, says: “More institutional investors are examining where their after-fee investment returns are going to come from in the coming years, and ARP funds have made a strong case.”
“Smoother returns, greater liquidity and lower fees are a very appealing combination for investors seeking diversification. If these strategies can successfully deliver on their objective, namely reasonable risk-adjusted returns over the cycle, we expect investors to increase their ARP allocations in the coming years.”
“However, the range of funds with track records of more than five years is limited.”
Cambridge Associates adds that investors considering an exposure to ARP funds should seek products that target factors proven over the long term and backed by multiple academic studies. While there are more than 300 potential factors targeted by ARP funds, most of these are not statistically significant.
