Note: an edited version of this paper first appeared in the 9/4/2017 Edition of IRIS

Liquid-Alternative Investing – Harvesting Risk Premiums Outside of Traditional Asset Classes

What is Liquid-Alternative (“Liquid-Alt”) investing?  Most Liquid-Alt strategies will target high absolute risk-adjusted returns where the underlying positions, generally invested in publicly-traded assets and derivatives, have low correlations to primary equity and fixed income market risks.  Since many of the strategies seek to neutralize these primary market risks, whether beta for equities or interest rate sensitivity for fixed income, some investors will seek to lever their positions to achieve higher returns, especially in a low yield/interest rate environment like the one we’re experiencing today. 

From a risk-factor perspective, Liquid-Alt investing can be viewed as an expansion of the traditional factor-based universe (i.e. Fama/French factors such as size, value, and quality as well as momentum, yield, and low volatility) to include alternative risk factors as displayed in Figure 1.[1]  By removing the short constraints and adding the ability to invest outside of traditional equities and fixed income, the Liquid-Alt investor is able to harvest more risk premiums than can be found in traditional asset allocation. 

Figure 1 – Common Factors Found in Alternative Investing

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[1] A full literature review of alternative risk factors goes beyond the scope of this paper.  We suggest you refer to 1) “Inside the black box – Revealing the alternative beta in hedge fund returns.” Romahi, Yazann et al., December 2016, J.P. Morgan Asset Management Investment Insights and 2) “Factor Investing Risk Allocation: From Traditional to Alternative Risk Premia Harvesting.” Maeso, Jean-Michel and Martellini, Lionel, Summer 2017, The Journal of Alternative Investments.