11/19/2019

Abbey Capital Limited

Managed futures: alternative risk premia?

In recent years there has been a huge increase of investment offerings in categorizations such as smart beta, alternative beta, style premia and alternative risk premia. Investors are increasingly assessing what is the value of these strategies versus traditional hedge fund offerings.

This note gives a brief overview of these alternative strategies, examines similarities and differences between managed futures and alternative risk premia strategies, and outlines some of the key issues investors should consider when choosing between these strategies.

The evolution of alpha and beta

The concepts of alpha and beta have their origins in the Capital Asset Pricing Model (“CAPM”), which was developed in the 1960s. The CAPM encapsulated the idea that equities had an element of diversifiable risk and an element of non-diversifiable risk. The non-diversifiable risk was the market risk or beta. If an investor held the market portfolio, they were capturing the market beta. Equally, if an investor actively managed a portfolio and generated a return in excess of that predicted by that portfolio’s beta, there was an element of skill, known as alpha or excess risk-adjusted return.
This produced a clear demarcation between alpha and beta in the investment industry. Passive, long-only, index funds aimed to capture the market beta (i.e. 100% market beta), actively managed long-only funds were a combination of market beta and alpha, while alternative investments such as hedge funds were 100% alpha. Hedge funds were seen as producing alpha, as returns were generated by gaining exposure to risk factors other than market risk or beta.

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