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Special report: Alternative risk premium strategies

Managers pointing to main factors that failed them in 2018

Keith Haydon said managers that ‘put all their eggs in one basket’ were hurt the worst.

Value, momentum, carry and defensive models all flounder at the same time

Updated with correction

Institutionally oriented alternative risk premium managers are licking their wounds after a difficult performance year for most and explaining to asset owners what went wrong in their strategies.

The performance of most alternative risk premium strategies, by industry definition actively managed, multiasset, long/short, factor-based approaches, was negative in the year ended Dec. 31.

That's because the four main factors many alternative risk premium investment models rely on — value, momentum, carry and defensive — were down or flat during the period, something sources said is extremely rare.

In fact, 2018 was only the year in the last seven when alternative risk premium strategies produced a negative average return, data prepared for Pensions & Investments by eVestment LLC, Marietta, Ga., showed. The eVestment dataset for these strategies is from 2012 onward.

In the year ended Dec. 31, the average return was -5.14% for the 22 alternative risk premium strategies tracked by eVestment. In contrast, the average return of these strategies was 7.98% in 2017 and ranged from a low of 2.03% to a high of 8.44% across the earlier five-year span.

Returns of alternative risk premium strategies recovered in the first quarter of 2019 at an average 2.46%, sharply up from the -3.02% return in the quarter ended Dec. 31, the eVestment analysis showed.

"2018 shone a spotlight on all ARP strategies," said Keith Haydon, the London-based chairman of Man FRM and chief investment officer of Man Solutions.

He noted it wasn't a good idea for alternative risk premium managers "to put all of their eggs in one basket. The problem was that if your strategy had a focus on a single factor — and many do — you suffered even more."

Man Group managed a total of $108.5 billion as of Dec. 31, including $10.6 billion for institutional investors in alternative risk premium strategies.

Still relevant

Performance notwithstanding, even worse for asset owners was the inability of these strategies in 2018 to provide promised diversification from traditional stocks and bonds within institutional portfolios, said Jeremy Bryant, senior vice president and leader of the research team at MJ Hudson Allenbridge Holdings Ltd., London.

Senior executives from some of the institutional alternative risk premium firms interviewed said their teams are actively engaging with investors, explaining why their strategies performed as they did last year and why they still are relevant to existing investors.

That conversation involves reminding investors that "ARP is not a volatility hedge. It's a great diversifying strategy that's defensive in nature. The return experience in 2018 was good because it helped to reset investor expectations," said Anthony Lawler, co-head and portfolio manager at GAM Systematic, the London-based alternative risk premium business of GAM Holding AG, Zurich, Switzerland.

Mr. Lawler said GAM's team has had numerous conversations with investors since the fourth quarter last year "explaining why 2018 was a challenging year and stressing the long-term diversification benefits of alternative risk premia. We've been showing investors our research, which found that nothing that happened in 2018 was specifically tied to ARP, but rather was the result of two significant drawdowns that resulted in high correlation and no positive returns."

GAM Systematic managed a total of $1.7 billion in alternative risk premium strategies of which $1.65 billion was managed for asset owners' alternative risk premium strategies as of Dec. 31. GAM Holdings managed $134.7 billion as of the same date.

Consultants and other managers also stressed the need for investors to manage their expectations and to remind themselves that alternative risk premium strategies won't produce positive returns every year but do provide portfolio diversification over longer time periods.

"The Holy Grail for alternative risk premia strategies is a positive expected return with negative correlation to risk assets (stocks and bonds) to diversify your portfolio in all markets. But that goal is like a unicorn, it doesn't exist. ARP strategies were hurt in 2018 and didn't provide diversification," said Christopher Solarz, managing director and head of global macro hedge fund strategies in the New York office of alternative investment consultant Cliffwater LLC.

Noted Christopher Walvoord, partner and global head of hedge fund research at Aon Hewitt Investment Consulting Inc., Chicago: "2018 was a difficult year, which helped to differentiate between alternative risk premia managers. A little bit of volatility helps to concentrate attention on the quality of your manager's strategy."

Most of the managers interviewed for this story declined to provide investment returns for their alternative risk premium strategies upon request.

However, investment consultants said a few alternative risk premium managers exited 2018 with positive returns from their strategies, including some of the managers with the highest levels of institutional assets, but declined to name them.

In its first deep dive into the universe of the most institutional alternative risk premium managers, Pensions & Investments found that AQR Capital Management LLC, Greenwich, Conn., topped the list of firms managing the most in alternative risk premium strategies for asset owners as of Dec. 31.

AQR managed $53.3 billion for asset owners, from a total of $56.1 billion in alternative risk premium strategies.

As of the same date, Man Group managed $10.6 billion for institutional investors from total of $11.7 billion managed in alternative risk premium strategies. Goldman Sachs Asset Management, New York, followed with a $7.3 billion managed in alternative risk premium strategies for asset owners from a total of $13.5 billion.

The 15 firms identified by consultants as managing the most in alternative risk premium strategies for institutional investors worldwide ran a total of $100.9 billion as of Dec. 31. Total assets managed worldwide in alternative risk premium assets by P&I's universe was $121.9 billion.

Assets managed for asset owners worldwide by P&I's alternative risk premium manager group represents a large proportion of the $150 billion to $200 billion estimated to be invested in all alternative risk premium strategies globally as of Dec. 31, showed research from MJ Hudson Allenbridge.

The largest managers of alternative risk premium assets
Ranked by worldwide alternative risk premium assets, in millions, managed for institutional investors as of Dec. 31, 2018.
RankManagersTotal assetsInstitutional assets
1AQR Capital Mgmt.$56,125$53,321
2Man Group$11,700$10,600
3Goldman Sachs Asset Mgmt.$13,500$7,300
4 BlackRock (BLK) $7,800$7,100
5GSA Capital Partners $4,000$4,000
6Capital Fund Mgmt.$4,300$3,700
7Pacific Inv. Mgmt. Co.$2,700$2,700
8J.P. Morgan Asset Mgmt. $3,772$2,607
9Magnetar Capital$3,100$2,500
10GAM Systematic$1,700$1,650
11Aspect Capital $1,700$1,500
12 AXA Investment Mgrs.$1,330$1,330
13Kepos Capital $1,300$1,300
14Systematica Investments$1,520$1,270
15Two Sigma Advisers$7,400N/A
Source: Company reports

Staying the course

Managers said during interviews that institutional investors haven't reduced or terminated their alternative risk premium investments, but the level of demand from institutional investors reported by managers this year varied quite a bit.

AQR Capital Management, for example, continues to see "quite a lot of demand and interest even after a difficult 2018," said Ronen Israel, principal and co-head of portfolio management, research, risk and trading.

Some of the new inflows this year into AQR's alternative risk premium strategies are from institutional investors that are "buying on the dip" because they think it's a good time to come in, Mr. Israel said.

The firm continues to converse with many of its institutional investors that "want to know why ARP behaved as it did in 2018. They're making sure the strategy isn't impaired," Mr. Israel said.

After spending "a tremendous amount of time" throughout 2018 researching the primary question clients were asking — "Has the world changed?" — Mr. Israel said AQR's team was able to assure its institutional clients that the team did not find evidence that the economic factors its strategy is based on had changed.

He said that after the intense review of the of the strategy "we were very much convinced that our core concepts and beliefs are right" and that over the long term, the alternative risk premium strategy is a good source of diversification and returns.

AQR managed a total of $196 billion as of Dec. 31.

Among other managers reporting reasonably high demand for their alternative risk premium strategies this year were GSA Capital Partners LLP, Magnetar Capital LLC and Two Sigma Advisers LP.

GSA Capital Partners, London, for example, is seeing strong interest in alternative risk premium strategies globally, especially from North American, Australian and Asian institutional investors, said Nathalie Esposito, head of business development.

Fees and transparency

Like other hedge fund managers in P&I's manager universe, GSA developed its risk premium strategies as a complement to its hedge fund strategies.

"Alternative risk premia strategies coincided with the decline in hedge fund alpha in recent years," Cliffwater's Mr. Solarz said.

"Hedge funds have been commoditized by hedge managers to replicate their hedge fund strategies without a performance fee with a much lower management fee," he added.

For example, David Khabie-Zeitoune, a GSA partner and CEO, said the firm's investment team was able to create alternative risk premium funds using some of the factor subsets within its hedge fund strategies.

"It created quite a bit of interest when we launched the trend-following alternative risk premia strategy in 2013 because we offered the fund at a flat 50 basis points with no incentive fees and a 14% volatility target," said Mr. Khabie-Zeitoune, noting that the price of GSA's alternative risk premium strategy compares well to the 2% management fee and 20% performance fee hedge fund managers charge for their trend-following hedge funds.

GSA Capital Partners managed a total of $7.5 billion in hedge funds and alternative risk premium strategies as of Dec. 31.

Man Group re-engineered internal hedge funds managed by its AHL and Numeric business units to meet institutional clients' need for a target return of 6% with a 6% volatility target, Mr. Haydon said.

The result was a suite of alternative risk premium strategies that provided hedge fund-like returns with lower fees, transparency and liquidity "to bridge the gap," Mr. Haydon said.

Although Man Group is close to its peak AUM in its alternative risk premium strategies, "the gradient of inflows has changed" and are "trickling in" so far this year, Mr. Haydon said, in contrast to the $5 billion of growth the firm saw in the strategies over the previous two years.

After explosive growth in its alternative risk premium strategy to $7.8 billion since it was launched in November 2015, BlackRock (BLK) found that net inflows began to slow in the second half of 2018.

Search activity has "paused" so far this year, but some investors are topping up existing alternative risk premium investments, said Sara Shores, San Francisco-based managing director and head of investment strategy in BlackRock's factor-based strategy group.

BlackRock managed a total of $6.25 trillion, including alternative risk premium strategies, as of Dec. 31.

Stronger average performance of alternative risk premium strategies in the first quarter of 2019 hasn't been enough to jump-start institutional investor interest, said Yazann Romahi, managing director, portfolio manager and chief investment officer for quantitative beta strategies at J.P. Morgan Asset Management (JPM), New York.

"Because 2018 was so difficult, even the first quarter rebound in ARP strategies isn't enough to reignite demand," Mr. Romahi said, adding that searches continue to decline.

J.P. Morgan Asset Management managed $1.987 trillion as of Dec. 31, of which $2.6 billion was in alternative risk premium strategies for institutional investors.