Editor’s Letter – Issue 134

July | August 2018

Hamlin Lovell

Amid many Alternative Risk Premia (ARP) launches, some are asking if ARP is likely to replace hedge funds. We expect ARP can expand the liquid alternatives market, without taking assets away from hedge funds. ARP strategies are generally based on transparent and well understood risk premiums that can be accessed through liquid markets. These risk premiums seem very powerful and persistent over multiple decades, but some of them have shown weaker returns over the past decade. Sharpe ratios from many standalone risk premiums, such as trend-following, currency carry trades, and value investing in equities, appear to have waned. Whether this is cyclical or structural remains to be seen, but ARP strategies do not generally appear to be using the very latest models, techniques, and data sources.

And ARP strategies may become progressively less likely to replicate hedge fund returns, as hedge funds are increasingly seeking to differentiate their strategies from generic risk premiums (and of course from their own ARP products). For instance, every equity market neutral manager I have interviewed stresses how their returns and factors are lowly correlated, or uncorrelated, to generic factors such as value, growth, momentum and quality that some ARP strategies are based on. Similarly, many CTAs demonstrate how their strategies use alternative data, some non-trend strategies, trade different time frames, and trade more and/or different markets.

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