Risk Premia Strategies Performance Overview - May 2022

Risk Premia Strategies Performance Overview - May 2022

9 May 2022
by Daniel Leveau, VP Investor Solutions & Navdeep Sahote, Product Manager at SigTech

Download SigTech's monthly performance analysis of risk premia strategies for an instant overview and comparison of each strategy's recent investment returns.

Risk premia strategies allow investors to benchmark returns in a more granular way than simply comparing returns to market performance. SigTech's risk premia strategies are grouped into momentum, value, carry and volatility factors.

We are publishing a monthly report overview on how these systematic strategies are performing.

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Written by Daniel Leveau, VP Investor Solutions

Capitalising on risk premia strategies

In the current environment of rising inflation, low yields and high valuation multiples, investors are hunting for new sources of alpha. Is building your own risk premia the obvious solution?

In this blog post we explore the history and advantages of bespoke risk premia strategies and give insights into the methodology for developing your own in-house strategies. SigTech publishes a monthly report of how risk premia strategies have performed, allowing investors to benchmark returns in a more granular way than simply comparing returns to market performance.

What are risk premia strategies?

A risk premia investment strategy isolates and systematically harvests excess returns from exposure to a specific risk factor such as value, momentum or carry. Such strategies are used by hedge funds, asset managers and asset owners as building blocks to create diversified portfolios.

Brief history

The academic foundation of risk premia dates back to the 50s when Markowitz published his seminal work around Modern Portfolio Theory. His groundbreaking research showed that the return of an asset is a function of its underlying level of risk. Based on this assertion, Sharpe later introduced the Capital Asset Pricing Model (CAPM) that defines a single market factor (known as the market beta) to explain an asset’s return.

Over the years, it became apparent that additional variables were needed to more comprehensively explain returns. As an extension to CAPM, Fama and French introduced their highly acclaimed 3-factor model that added size and value as explanatory variables, later to be expanded by Carhart who added the momentum factor to what has become known as the 4-factor model.

Lately, the number of explanatory variables - or risk factors - identified have exploded. Famously, Harvey minted the expression “factor zoo” to make the point that “the factor production has gotten out of control”. As of today, he has identified more than 400 factors presented in academic papers that claim to generate a positive risk premia.

The validity of classic risk factors such as value, momentum and carry are mostly undisputed, whereas more esoteric factors such as lottery demand, hiring rate and non-myopic beta lack wide-spread recognition. In addition, it is important to note that many of the newer factors have a strong commercial link and their objectivity from an academic perspective is debatable. To find out more, you can access Harvey’s full list of factors here.

The existence of risk factors and their corresponding premia can be explained by various structural conditions or behavioural biases. For example, the tendency for asset prices to revert to a long-term fair value (mean reversion) underpins the risk factor value, herd mentality explains momentum, and mispricing due to supply/demand imbalances for e.g. commodities results in carry opportunities.

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SigTech’s risk premia

Using our market leading research and backtesting platform, we have built a set of risk premia strategies for our monthly benchmark report. The report provides a comprehensive performance overview alongside commentary on cross-asset risk premia.

As the number of risk factors used to create risk premia strategies has expanded exponentially, it is important to define the underlying fundamental principles that the strategies should comply with.

The four fundamental requirements of risk premia

Risk premia are either structured as long/short (“alternative risk premia”) or as long-only portfolios (“smart beta”). SigTech’s risk premia strategies are long/short portfolios and cover the multiple asset classes (i) equity indices, (ii) single stocks, (iii) fixed income, (iv) FX, and (v) commodities. We calculate risk premia for each asset class using the following risk factors:

Risk Premia Strategy Types

Wherever possible, we apply a universal methodology across the asset classes to mitigate risks of overfitting. The table below shows an overview of our methodology for each asset class and risk factor.

Risk premia asset class/strategy table

Creating bespoke risk premia

SigTech’s quant technology platform offers investors access to a sophisticated backtesting engine with clean and curated data across asset classes. Applying SigTech’s transparent and modular framework enables you to efficiently create bespoke risk premia strategies based on your individual requirements and situation.

In addition to changing the underlying methodology (see table above), the granularity at which you can customise your strategies is almost limitless. For instance, you can impose limits on concentration risk and leverage, apply FX (foreign exchange) hedging, take specific trading commission rates into account, your market impact assumptions, current market conditions, and factor in specific tax situations.

Risk premia strategies have a long and varied history in investing, but remain valid to this day. By adding bespoke risk premia in their investment portfolio construction to achieve attractive risk-adjusted returns, investors see a myriad of benefits.

Benefits of risk premia strategies

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