Trend-Following CTAs vs Alternative Risk-Premia (ARP) products: crisis beta vs risk-premia alpha
Sepp A., Dezeraud L., (2019), “Trend-Following CTAs vs Alternative Risk-Premia: Crisis beta vs risk-premia alpha”, The Hedge Fund Journal, Issue 138, pages 20-31
23 Pages Posted:
Date Written: January 31, 2019
We propose a quantitative model to explain the risk of systematic investment strategies by accounting for their exposures to equity tail risk, such as shorting volatility and credit protection. We apply this model to the cross-sectional risk attribution of about 200 composite indices of hedge funds and alternative risk premia (ARP) products. We show that there is a strong linear relationship between risk-premia alpha and the tail risk of systematic ARP strategies. We demonstrate that our model explains nearly 90% of the risk-premia for volatility strategies and about 35% of the risk-premia for hedge fund and ARP products. In this way, most ARP and hedge fund type products are seen as risk-seeking strategies.
We illustrate that trend-following CTAs are exceptions since they belong to defensive strategies with negative market betas in bear regimes, yet risk-premia alphas for CTAs are insignificant. CTAs cannot be seen either as ARP products with positive risk-premia alpha from exposures to tail risk, or as defensive products with negative risk-premia designed to reduce tail risk, such as long volatility strategies. Instead, trend-following CTAs should be viewed as an actively managed defensive strategy with the goal to deliver protective negative market betas in strongly downside markets along with risk-seeking positive market betas in strongly upside markets.
Finally, we show that because of the negative protective betas in bear markets, trend-followers well deserve their place as diversifiers in alternative portfolios to improve risk-adjusted performance and capture risk-premia alpha on a portfolio level.
Keywords: Trend-Following, CTA, Tail Risk Hedging, Quantitative Investment Strategies, Alpha, Skewness, Convexity
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation