Although factor investing and smart beta have gained in popularity, the emergence of alternative risk premia points to a critical focus for plan sponsors today: risk diversification. This is happening at a time when plans are shifting increasingly away from bonds and equities and into alternative investments.
“Alternative risk premia provide a different route to different risks than equities, bonds, credit, and commodities,” explains Vikas Kapoor, co-head, custom alternative solutions, AllianceBernstein. It’s evidence, he explains, that “there are many risk premia — but not all are created equal.”
Kapoor notes that while plan sponsors have turned to alternative investments like private equity and structured credit, these investments don’t always do what they’re intended to in a portfolio — particularly in the late stage of the business cycle.
“In the later stage, they tend to behave like other things in the portfolio,” he says, meaning that their diversification benefits decline at certain times.
Hedge funds as well have traditionally been used for diversification — but they, too, come with challenges such as fees, a lack of transparency, and illiquidity. And some types bring risks you might not want in your portfolio —directional risk, for example, with much of it derived from beta. Idiosyncratic risks are another issue with hedge funds— “put together, you are taking specific risks for a small return,” he says.
That’s where alternative risk premia can be helpful —in truly diversifying a portfolio away from stocks, bonds, and credit. Take value, for example. It can be extended to currencies, commodities, and bonds to add diversification. “Because what’s happening to cheap stocks is much different than what’s happening to cheap commodities,” Kapoor adds.
Another alternative risk premia strategy can be found in tracking the signals between asset classes through liquid hedge funds. “There is a rich set of strategies available within this broad classification of alternative risk,” he says.
Ultimately, alternative risk strategies can help plan sponsors understand the risks in their portfolio and address them in a meaningful way. It’s not just about equities, bonds, and credit — there are many risks, including tail risk, that ought to be addressed, yet are too often left open.