Alternative risk premia and a fundamental explanation
Numerous portfolios are mostly dominated by equity market risks. In the face of global economic crisis, this may not be favourable to the various investors. Thus, it is usually advisable that investors seek other sources of returns into their portfolios. The savvy investors therefore recognise the need to include alternative sources of return that completely avoid these market risks (market-neutral alternative sources), to complement their portfolios.
Coming through the years, investment has been having a continuous growth spurt. This has given the opportunity to previously novel investment strategies such as Alternative Risk Premia to take the front stage in investment. Alternative Risk Premia or Alternative Risk Premium (as it was formally called) is fast becoming a veritable option as opposed to Traditional Risk Premia. Alternative risk premia involves a myriad of systematic approaches applied to investing, that have the ability to generate profitable returns in various markets and assets groups in the long run.
Alternative Risk Premia
Alternative risk premia is founded on the belief that human behavior is essential in driving of asset prices that result in systematically exploitable opportunities; these opportunities commonly have no connection to wider macro fundamentals.
Alternative Risk Premia basically is an upgrade on the Factor Investing Approach common in equities which gives investors and asset owners a better understanding of how diversification of portfolio works and capturing new sources of returns. As can be immediately deduced from the name, Alternative risk premia are alternatives to traditional risk premia and can take the form of both long and short investment.
While traditional risk premia are limited in scope to only long investments with just one given asset class, alternative risk premia however, are quite complex, they can be found in all asset classes including equities, rates, credit, commodities, etc.
Alternative risk premia constantly have some interactions with traditional risk premia despite their differences. However, when it comes to exposure to macro risk factors, alternative risk premia are exposed to a wider range. Some of these risk factors to which alternative risk premia are exposed include: behavioural biases, human preferences, investment styles and investor constraints. Despite this, various research, statistics and investor experiences have proven that alternative risk premia can still offer enticing risk-adjusted returns, even over multiple, asset groups regardless of whether or not they are related, and in various locations.
ALTERNATIVE RISK PREMIA
Types of alternative risk premia
The various Alternative risk premia and the fundamental justification for their existence