Understanding the role of alternative risk premia

Investors are increasingly looking for opportunities to tap into alternative risk premia. Here we consider four categories of alternative risk premia that we have found to be historically persistent and potentially profitable. We examine the objective of each and share our views on implementation options and challenges, as well as the importance of portfolio construction.

SEEKING TO EXPAND THE CONVENTIONAL ASSET ALLOCATION OPPORTUNITY SET, many investors are turning to alternative risk premia and their potential for differentiated return streams with low correlation to traditional markets. In this introduction to alternative risk premia, we define the concept and then highlight four categories of alternative risk premia that we have found to be historically persistent and potentially profitable. We examine the objective of each category and share our views on implementation options and challenges. Finally, we outline our beliefs about the importance of portfolio construction in the alternative risk premia space.

Defining alternative risk premia

Alternative risk premia are the potential returns that exist either as compensation for taking risk or as a by-product of behavioral biases. Setting aside the nomenclature for a moment, which is less familiar to some, the underlying concept is well known to most. For years, investors have been harvesting traditional premia, such as the equity risk premium and bond term premium. One hallmark of traditional risk premia is that they can be captured with long-only investments. But alternative risk premia require the use of long and short trades to capture any returns. They are harvested using rules-based, systematic investment processes.

A robust and well-diversified alternative risk premia portfolio can, by design, be market neutral and consequently may help mitigate the impact of market volatility while potentially…

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Before investing, consider the risks that may impact your capital. Your investment may become worth more or less than at the time of the original investment. Please refer to the risk section near the end of the PDF available above. We have no “house views,” and the perspectives of our investors often vary.

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