’Hedge fund alternatives’ pass their first test, says Cambridge Associates


Alternative Risk Premia (ARP) funds – a newer breed of ‘hedge fund alternatives’ – passed their first test during the market correction in the fourth quarter of 2018 by outperforming other comparable major asset classes.

That’s according to research from Cambridge Associates which reveals that during Q4 2018, equities returned -13.7 per cent and equity hedge funds returned -9.3 per cent, compared with -4 per cent for ARP funds. While these returns show promise, Cambridge Associates says longer-run data is still needed before making a judgement on ARP funds as an asset class.
 
Alternative Risk Premia funds may be added to a pension fund’s traditional portfolio of equities and bonds to diversify returns and lower risk. Investors see the asset class as a lower-cost alternative to hedge funds, with fees typically ranging between 0.5 per cent and 1 per cent. This compares favourably with the traditional ‘2 and 20’ fee structure that is still common in the hedge fund industry.
 
The asset class has grown quickly since 2016, with Cambridge Associates’ research now covering USD73 billion of assets in 33 ARP funds globally.
 
ARP funds look to exploit persistent risk premia that create biases in asset prices and can lead to higher returns. While there are potentially hundreds of risk premia to target, diversified ARP funds generally invest across a combination of major risk premia, which have been proven over the long term by multiple academic studies:
 
• Value – investments that are priced cheaply tend to outperform
• Momentum – Investments that have recently outperformed tend to continue outperforming
• Carry – Investments that offer higher yield tend to outperform
• Quality – Investments tied to higher-margin, less-levered and more consistently profitable businesses tend to outperform
 
Over the last five years, Cambridge Associates’ data shows that a pension fund adding a 30 per cent allocation to ARP funds to a balanced portfolio of global equities and bonds denominated in Euro improved risk adjusted returns, compared with a 30 per cent allocation to a range of other diversifying assets.
 
The portfolio with ARP fund exposure returned a cumulative 37 per cent over the last five years, compared with 35 per cent for a portfolio including trend-following hedge funds and 31 per cent for a portfolio including Diversified Growth Funds. Those better returns were also delivered with lower volatility.
 
Trudi Boardman, Senior Investment Director at Cambridge Associates, says: “Although it was only a short-term test, the performance of ARP funds in the fourth quarter of 2018 showed reasons to be optimistic for their longer-term returns.”
 
“For pension funds, many of whom have a clear need for liquid diversification, ARP funds merit consideration, particularly as an alternative to hedge funds or diversified growth funds.”
 
“The potential for smoother returns, greater liquidity and lower fees will be very appealing to pension funds if ARP funds can successfully deliver on those objectives over a full cycle.”

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