Updated with correction
At the request of their institutional clients, hedge funds-of-funds managers are researching ways to combine beta-isolating risk factors and alpha-producing hedge funds to offer cheaper, higher-return, more diversified strategies.
Hedge fund managers have used risk factors to inform their implementation and timing of trades for years, but the move by hedge funds-of-funds managers to identify, analyze and deconstruct hedge funds' sources of alpha and beta is, for the most part, only just revving up in response to client demand, observers said.
The nascent trend is fueled to some extent by investor desperation, given the poor outlook for returns from traditional equity and fixed-income investments for the foreseeable future, observers noted.
“Investors, however reluctantly in some cases, have turned to alternatives for return. Adding alternative beta sources is right in the crosshairs of what institutional investors want now,” said Keith Haydon, chief investment officer, based in the London office of Man Group PLC's FRM hedge funds-of-funds unit.
Risk-factor investing assumes that risk premiums — the return from holding assets that carry risk — can be identified by a wide array of factors beyond simple market risk. Those risk premiums usually are captured systematically through passive replication strategies or through portfolios constructed using a combination of risk factors. The range of risk factors tracked is wide, including value, size, momentum, quality and volatility, sources said.
Firms that are taking a close look at alternative beta as a means to provide clients with solutions — primarily better returns, liquidity and diversity — for their hedge fund or overall portfolios certainly hope the endeavor will turn into a money-making strategy.
Among managers that are investigating risk-factor investment opportunities are Blackstone Alternative Asset Management and Pacific Alternative Asset Management Co. LLC.
The transition from a research project to the rollout of a profitable investment strategy might be long, if it happens at all.
“We've been researching systematic risk-factor investing for a decade, but we weren't holding a hammer looking for a nail,” said William Park, managing director and head of investment risk and strategy, who is based in the Stamford, Conn., office of UBS Hedge Fund Solutions.
“It wasn't until recently when certain clients said they wanted daily liquidity in a portfolio of hedge funds that we started seriously looking for a solution using risk factors,” Mr. Park said.