Investors ditching alternative risk premia on poor returns
Asset owners in Asia, the US and Europe are ditching alternative risk premia (ARP) strategies as dreadful returns so far this year cap two years of stark underperformance.
ARP funds employ multiple so-called factors – such as value, momentum or low volatility – to measure and invest into asset classes such as equities, commodities, fixed income and currencies, with a view to outperform the market. The funds typically charge fees of between 0.5% and 1%, a rate that asset owners initially found very appealing when compared to expensive active managers such as hedge funds.
However, ARP is having its worst year on record. In the six months to June 30 the ARP composite index of investment consultancy Bfinance was down 11.35% for the year, compared to a drop of 5.8% in the MSCI World.
This year’s poor returns follow similar bad relative performance in 2018 and 2019. That has led US retirement plans to make big redemptions both last year and this one, said Matt Talbert, senior investment manager at the Teacher Retirement System of Texas, a $160 billion public pension fund.
He believes they are likely to continue.
“We would anticipate general outflows from alternative risk premia and more concentrated outflows in the worst hit spaces until performance turns the corner,” Talbert told AsianInvestor.
Moreover, London-based Pool Re, a terrorism risk reinsurer with £6.5 billion ($8.4 billion) under management, could potentially abandon its 2.5% allocation to ARP, chief investment officer Ian Coulman told AsianInvestor.
“We’d have to see a significant turnaround in performance in the next six to 12 months to definitely say we’re sticking with it,” he added. “At the moment we’re disappointed, but we’re holding on. We are monitoring [performance].”
Pool Re’s ARP allocation, for example, dates from early 2018. It has invested it via three quantitative managers, whose strategies encompass equity, fixed income, currencies and commodities combining risk premia strategies of trend, momentum, volatility, low beta, carry and quality and value.
“Everyone agrees that ARP managers have faced outflows this year, with other ARP managers struggling to raise funds. A lot of investors are questioning the value [of ARP],” said Antti Suhonen, London-based senior adviser at MJ Hudson, an investment consultancy.
If anything, Asian asset owners are even more disappointed with ARP, according to a survey conducted in June by Bfinance.
Seven in 10 (69%) of those invested in these strategies in Asia said they were dissatisfied with their performance in 2020. That was even higher than the global figure of 62%. Nearly half (44%) of Asian investors surveyed said they allocated to ARP, rising to 63% of those in Australia.
WORST YEAR ON RECORD
Kathryn Saklatvala, London-based head of investment content at Bfinance, told AsianInvestor the popular factor of value has been particularly hard hit.
The MSCI World Value, a type of ARP index, was down 15.25% in the year to the end of July and has returned an annualised 0.06% over the last three years. In comparison the MSCI World index, a standard market capitalisation-based index, recorded respective figures of -0.93% and 8.12%.
Certainly, Canada Pension Plan Investment Board has taken heavy losses on ARP. Its risk premia strategy programme lost C$1.0 billion ($760 million) in the year to March 31. In its annual report to end March 31, CPPIB said the majority of these losses were sustained in March 2020.
Worst hit in the risk premia portfolio was the volatility strategy, which lost C$700 million. Its losses came “mostly in equity and commodity volatility that reflected the chaotic market environment and the drop in crude oil prices”, according to the annual report.
REDEMPTION TIME
The sustained poor performance has led institutional investors in Europe and North America to redeem both external mandates and funds and internal allocations to ARP this year, said investors and consultant. AsianInvestor could find no data for industry-wide ARP flows
Talbert would not been drawn on whether Texas Teachers would redeem from its ARP investments, but acknowledged it was a difficult time.
“It is going to be a tough call for our management,” he said. “[Internal managers like me] find ourselves always wanting to cheerlead for our strategies, but it is going to be harder for us,” he said.
It is hard to say what has been responsible for the poor performance, but Texas Teachers’ internal research shows that outflows were accelerating poor performance. “Research provided by managers denies that is a problem, but it seems that is driving a lot of the underperformance,” he said.
Chris Reeve, of Aspect Capital, a $6.6 billion London-based fund manager that has several ARP products, told AsianInvestor that losses had largely been taken by managers with a high weight in underperforming factors, such as equity value, and that many multi-factor ARP strategies had performed well.
Look out for the second of this two-part series shortly, in which AsianInvestor will assess whether it’s worth keeping faith in ARP strategies, and if so which ones.