Dynamic Strategy Migration and the Evolution of Risk Premia

Abstract

The author creates a conceptual model for risk premia strategies, focusing on the notion of a continuum running from pure alpha to pure beta and where on this continuum a given manager or investor would like to engage with the markets. He suggests that a risk premium that is nearly completely unknown is really a source of alpha, which then becomes more risk premia–like as it gains market acceptance. As such, there is an inexorable pull toward commoditization for any known and profitable investment strategy. A key question for both risk premia asset managers and investors is how to operate in this dynamic environment. The investment manager might consider how to adapt and perhaps research and migrate to new, less-commoditized strategies over time. The investor must decide what mix of managers along this continuum to select. Finally, the author provides empirical evidence that naïve versions of some of the most known risk premia strategies have indeed shown signs of commoditization in the post-crisis period as compared to the pre-crisis period. Broadly, he suggests that in the face of investment strategy degradation, investors and managers must consider adaptive approaches to the markets and to upgrading their strategies or strategy allocations.

TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing

Key Findings

• • Alternative risk premia (ARP) strategies tend to experience an inexorable pull toward efficiency, commoditization, and beta over time, especially as new market participants enter the space to take advantage of ARP opportunities.

• • Key questions then involve where on the spectrum running from alpha, to risk premia, to something more akin to beta managers and investors want to operate and how to migrate away from strategies that may have deteriorated.

• • These are important considerations given that there is indeed some evidence that performance/diversification deterioration has occurred in typical ARP strategies. The author suggests that an adaptive, innovative approach to ARP may be ideal.