Benchmarking Alternative Risk Premia

September 2020

bfinance
Originally published in the August | September 2020 issue

A challenging period for factor investing has left investors scrutinising the performance of Alternative Risk Premia strategies and managers. In a sector where benchmarking has generally been problematic, this evaluation is now helped by the emergence of a the first fundamentally constructed, comprehensive ARP index.

The latest bfinance Asset Owner Survey (July 2020) indicated that, of the 27% of investors that use Alternative Risk Premia, nearly two thirds (64%) were dissatisfied with 2020 YTD performance “relative to benchmarks or targets” – the worst feedback among all sixteen asset classes assessed. Not coincidentally, Hedge Funds and Smart Beta also sat in the bottom four (Fig.1). Examination of performance to end-Q2 showed the average ARP manager losing 11.35% through H1 and losing 4.14% per year over the last three years (see page 12). Although there has been considerable dispersion and most cases of poor performance are clearly attributable to difficulties in certain factors, these headline figures are problematic.  

As with hedge funds, there is a burden of expectation that ARP will deliver in challenging periods – an expectation that can be disappointed.

Yet how can investors gain a robust understanding of performance? Both hedge funds and ARP undoubtedly struggle with the core premise of assessing performance relative to appropriate targets or benchmarks: as a rule they are judged against absolute return objectives, supplemented by peer comparisons of varying relevance and indirectly relevant benchmarks. To some extent this is unavoidable for hedge funds, in that they typically aim to be idiosyncratic. In contrast, ARP seeks to derive its returns from exposures to known factors or investment styles; it is not unreasonable to want to compare ARP investments against a canonical set of premia.

Enter the newly launched suite of ARP benchmarks from Bloomberg and Goldman Sachs Asset Management, which are profiled in this brief report1. While absolute returns will likely continue to be the mainstay for judging the ‘success’ of a set of strategies whose explicit intention is to provide portfolio diversification, these promising new yardsticks will help to add clarity as investors seek to understand returns, evaluate managers and reassess strategies. 

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