Following heavy losses on alternative risk premia (ARP) strategies investors have grown increasingly sceptical of such investments. But some asset managers and owners say these types of investments still have a role to play in portfolios, depending on the risk factors they incorporate and how they are combined.
ARP seeks market neutral exposure, by using long and short exposure to traditional risk factors, such as value, momentum or low volatility. They typically invest across asset classes such as equities, commodities, fixed income and currencies. With fees typically ranging between 0.5% and 1% such strategies have proved attractive alternatives to active managers, including hedge funds.
During 2020, ARP mandates designed specifically to be defensive have done better than other ARP strategies, said Matt Talbert, senior investment manager at the Teacher Retirement System of Texas, which has $160 billion under management.
“This is one of the benefits of customised mandates with broker dealers, in which you can embed more explicitly defensive structures,” he said, pointing to the use of put options to create a stop loss or an explicit equity tail hedge. “That has served a lot of folks well in the first quarter of this year.”
Indeed, investors and consultants note that multi-asset strategies have performed better this year. By contrast, so-called “single stock strategies,” which apply filters based on one or more risk premia to single stocks have done worse. Many of the single stock strategies are influenced heavily by the academic research and run by managers with an academic background.
A study of 28 ARP funds (that used both long and short strategies) over the first half of 2020, published in July by UK investment consultant MJ Hudson found that the worst performance had come from so-called ‘applied academic’ funds, typically single stock strategies, which lost 17.7% on average. This was largely down to the weak performance of classic risk premia factors such as equity value.
The second group – with a macro or CTA background, who typically identify opportunities in indexes, rather than single stocks – on average lost 3.6%. Just four of the 28 funds have recorded a positive return year-to-date.
“The weak performance of classic risk premia factors, especially in the single stock equity space, have made a significant negative contribution to many of the funds in the second group,” the MJ Hudson report observed.
In July, Greenwich, Connecticut-based AQR Capital Management, one of the best known managers in the single stock equity space (which also offers other strategies), cut management fees on eight funds, including its $1 billion AQR Large Cap Multi-Style fund, by between 5 and 25 basis points (bp) down to 5bp, according a filing with the Securities and Exchange Commission (SEC).
It is hard to say what was responsible for the poor returns across ARP, noted Talbert, but internal research has shown that outflows were accelerating performance losses, with single-stock strategies the most susceptible to outflows, “Research provided by managers denies that is a problem, but it seems that is driving a lot of the underperformance,” he said.
Among single-stock long-short strategies redemptions require managers to unwind short positions, where liquidity can disappear quickly, resulting in heavy losses, said Antti Suhonen, senior adviser at MJ Hudson and author of the July report, told AsianInvestor.
The performance of risk factors has continued to diverge this year, extending a shift that dates back to 2017.
The MSCI World Momentum Index was up 11.57% in the year to the end of July and 15.86% over three years. The MSCI World Quality Index was up 6.29% and 15.11% respectively. This contrasts with the -15.25% and 0.06% for MSCI World Value over the same period, and -0.93% and 8.12% for MSCI World.
“For equity value, there has been nowhere to hide – globally, long or short across all sectors performance has been hit,” confirmed Deepak Gurnani, founder of ARP Investments in New York. His firm manages some $1 billion in ARP strategies for institutional investors, including between $100 million and $200 million for Asian, mostly Australian, investors.
Gurnani said the company employs 15 measures of equity value, all of which had shown negative returns this year, he said. However, the firm’s main largest strategy, a multi-asset global macro programme encompassing 40 underlying factors had seen positive returns this year, although the firm declined to say by how much.
“Value has been a particular problem,” agreed Ian Coulman, CIO of London-based Pool Re, a terrorism risk reinsurer with £6.5 billion under management. “Several of our managers cut exposure going into the later part of the first quarter to de-risk, but weren’t able to put risk back on as the market recovered so sharply,” he said.
Coulman noted how big a role that the large technology stocks (all growth stocks) had played in equity market recovery and pointed to continued poor performance of financials and energy (value stocks), throughout the year.
Talbert rejected capacity constraints as an explanation for recent underperformance – that is, the idea that too much investor money in a strategy causes the risk premium to disappear.
“I’m not convinced these strategies are more crowded than before,” he said. Suhonen agreed: “Outside the very niche strategies, such as alternative risk transfer, there is not enough money to cause crowding.”
STILL A ROLE
Yet for all of the poor track record of ARP of late, Talbert said he had not yet lost faith in the benefits of the strategy in terms of diversification and return.
“There is a long track record of these strategies working. Certainly, the scale and the length of the drawdowns are disheartening. But it’s not quite time to give up,” he said.
Kathryn Saklatvala, London-based head of investment content at Bfinance said that there was still a core conviction in ARP’s benefit as a long-term diversification from equities and the academic evidence for the existence of risk premia and investors were still committed allocating between 5% and 10% to “liquid diversifying assets”, a category including hedge funds, multi-asset strategies and ARP.
However, she expected to see significant manager turnover in the coming months. “We don’t see investors flocking for the exits, but there is a lot of revaluation around managers and, particularly, strategies.”
“ARP remain valuable as diversifiers uncorrelated [with other strategies] over time, but they are not going to be totally immune from equity market sell offs,” added Chris Reeve, of Aspect Capital, a $6.6 billion London-based manager. “Uncorrelated doesn’t mean negatively correlated. [ARP strategies offer] a diversifier, not a hedge.”