Alternative Risk Premia: What Do We Know?

Abstract

The concept of alternative risk premia is an extension of the factor investing approach. Factor investing consists in building long-only equity portfolios, which are directly exposed to common risk factors like size, value or momentum. Alternative risk premia designate non-traditional risk premia other than a long exposure to equities and bonds. They may involve equities, rates, credit, currencies or commodities and correspond to long/short portfolios. However, contrary to traditional risk premia, it is more difficult to define alternative risk premia and which risk premia really matter. In fact, the term "alternative risk premia encompasses" two different types of systematic risk factor: skewness risk premia and market anomalies. For example, the most frequent alternative risk premia are carry and momentum, which are respectively a skewness risk premium and a market anomaly. Because the returns of alternative risk premia exhibit heterogeneous patterns in terms of statistical properties, option profile and drawdown, asset allocation is more complex than with traditional risk premia. In this context, risk diversification cannot be reduced to volatility diversification and skewness risk becomes a key component of portfolio optimization. Understanding these different concepts and how they interconnect is essential for improving multi-asset allocation.

Keywords: alternative risk premium, factor investing, skewness risk, market anomalies, systematic risk factor, diversification, carry, momentum, value, low beta, short volatility, payoff function, alternative beta, hedge funds, multi-asset allocation

JEL Classification: C50, C60, G11