Investment Strategies: Understanding Traditional and Alternative Risk Premia
Investing in the financial markets requires a thorough understanding of the different types of risk premia available and how they can contribute to a well-diversified investment portfolio. In this article, we will explore the concepts of traditional and alternative risk premia, their characteristics, and how they can be incorporated into an investment strategy.
Traditional Risk Premia
Traditional risk premia refers to the additional return that investors receive for taking on additional risk compared to a safe investment such as a government bond. This type of risk premia is commonly associated with traditional asset classes, such as equities, bonds and commodities. For instance, investing in stocks is generally considered to be riskier than investing in government bonds, but the expected return from stocks is higher to compensate for that extra risk.
Traditional risk premia is typically achieved through a combination of dividends and capital appreciation. For example, dividend-paying stocks offer a steady stream of income, while growth stocks offer the potential for capital appreciation. Bondholders receive interest payments, which represent a form of risk premia for the risk of lending money to the issuer.
Alternative Risk Premia
Alternative risk premia, on the other hand, refers to investment strategies that seek to capture return premiums from sources other than traditional asset classes. These strategies aim to identify and capture return premiums from alternative sources of risk, such as volatility, carry, momentum, and other market anomalies. Over the past thirty years, academics and practitioners have identified these premiums, commonly referred to as factors.
Alternative risk premia strategies typically involve the use of quantitative methods and sophisticated investment techniques, such as statistical arbitrage, factor-based investing, and derivatives. They can be used as standalone investments or as a complement to a more traditional investment portfolio, with the goal of improving overall portfolio diversification and reducing the impact of market volatility.
Examples of alternative risk premia strategies include long-short equity, managed futures, global macro, and multi-strategy hedge funds. These strategies can provide diversification benefits, low correlation to traditional assets, and the potential for higher returns. However, it’s important to note that alternative risk premia strategies can be complex and may involve a higher degree of risk compared to more traditional investment strategies.
Summary
Investors have access to both traditional and alternative risk premia through a well-diversified investment portfolio. Traditional risk premia is often associated with traditional asset classes, such as equities and bonds, and is achieved through a combination of dividends and capital appreciation. Alternative risk premia refers to investment strategies that seek to capture return premiums from sources other than traditional asset classes.
KM cube’s platform provides clients with access to both traditional and alternative risk premia strategies, customized to their investment approach that best aligns with their financial goals and risk tolerance.