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Investing for the future: Alternatives 2.0

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By Fiona Frick, Unigestion – In a world where returns from traditional asset classes are under pressure, many investors are turning to alternative investments to boost their portfolio's performance potential. However, although an allocation to hedge fund strategies offers potential for attractive risk-adjusted returns and portfolio diversification, the low interest-rate environment has thrown the issue of fees into stark relief.

There is little doubt from our experience that skilled hedge fund managers provide a valuable source of uncorrelated alpha for long-term investors. However, advances in quantitative modelling have challenged traditional definitions of alpha and raised the possibility of accessing alternatives in a more cost-effective way.

A new paradigm for defining hedge fund returns

Academic research has questioned the unique attribution of hedge fund returns to market beta plus alpha, less fees. 

The reality is more nuanced, with much of what was thought of as alpha proven to arise from differentiated alternative risk premia which can be captured through liquid investment strategies. There is still room for true alpha, but this opens up the possibility of a new way of accessing alternative investment returns. 

Alternatives 2.0: how Unigestion combines alternative risk premia and hedge funds

We believe that harvesting risk premia and generating alpha are best viewed as separate categories, to reflect very different liquidity terms and pricing structures. Drawing on our expertise in this area, we combine a directly managed allocation to alternative risk premia with a number of carefully selected diversifying third-party hedge funds, selected for their ability to generate uncorrelated alpha.

The result is an integrated alternatives solution, with the characteristics many investors are looking for and which can also overcome many of the challenges associated with traditional approaches such as high costs, liquidity and transparency.

Constructing the Alternative risk premia core

Not every risk commands a premium, and considerable work is required to establish which risk factors deliver sustainable and economically meaningful risk premia. Today, our knowledge and experience lead us towards long/short equity factors, trend following and carry strategies, although we keep this under constant review. 

We then apply Unigestion's risk-management process to create liquid and investable portfolios with attractive risk characteristics. Since alternative risk premia bear specific risks typical of long/short strategies, our proprietary risk models go beyond volatility, taking into account asymmetry, tail risk and illiquidity risk. It is our long-held belief, backed by experience, that risk management is a key driver of sustainable long-term performance.

Based on our understanding of the macroeconomy and the sensitivities of alternative risk premia to the business cycle, we then define the most efficient capital allocation to create well-balanced exposure to macroeconomic regimes and manage it dynamically.

Adding uncorrelated alpha from hedge funds

While alternative risk premia can be harvested efficiently in this way, genuine alpha, which cannot be explained by risk factors, remains valuable for portfolios as a source of uncorrelated returns. 

We strongly believe that top hedge fund managers can deliver a substantial degree of alpha. Manager selection is crucial here, and Unigestion has a 30-year track record of researching and selecting high quality managers. As one of the first in the industry to establish a dedicated operational due diligence team, we believe that our experience in this field and in-depth understanding of each manager we invest in leaves us well placed to identify suitable managers to complement the core exposure to alternative risk premia.

With a thorough understanding of the components of hedge fund returns comes the ability to construct a truly diversified portfolio. Key to this is our comprehensive analysis of each manager's sources of return using advanced modelling tools we have developed. In this way we ensure low correlation with alternative risk premia as well as low cross-correlation between the different managers we select. 

An integrated alternative solution built for the future

In a world where traditional investments may come under pressure, interest in alternatives remains high, but a new way of accessing these returns is needed.

Drawing on the deep experience of Unigestion's equity, multi-asset and alternatives teams, we believe Alternatives 2.0 is the right solution for many investors to access in a new and cost-efficient way the return potential of alternative investments. 

We believe this sets us apart from hedge fund managers, who will tend to treat alternative risk premia as alpha, producing a very different portfolio composition. Our approach is also quite different from pure quantitative managers, whose models tend to rely on historical correlations and which can prove less reliable at times of inflection in the markets.

Furthermore, our extensive experience of working with clients permits us to co-create holistic alternatives solution which addresses the challenge of costs, liquidity and transparency in a uniquely modular and flexible format. 

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