Is Alternative Beta the New Fixed Income?
Written by: Yazann Romahi, Chief Investment Officer of Quantitative Beta Strategies and Lead Portfolio Manager of JPMorgan Diversified Return International Equity ETF at J.P. Morgan Asset Management
The fee debate raging across mutual funds has long since seeped into hedge funds.
Certainly the direction of travel on hedge fund fees was already downward, as strong industry competition and underwhelming performance have taken their toll. But now as the ability to access certain hedge fund-like returns becomes more readily available in liquid, cost efficient mutual fund formats, the convergence has picked up speed.
In our view, this can only be a good thing for investors. Indeed, we would argue that in what appears to be a rising rate environment on the horizon, lower cost hedge fund-like exposure offers an interesting and diversifying alternative to holding fixed income.
The quantitative cat is out of the bag in the hedge fund world. As we all know, a growing number of academic studies suggest that systematically harvesting a number of well-rewarded factor premiums, such as value, size or momentum, can help ensure enhanced returns in the long run, both in equity and bond markets. A number of industry surveys suggest that institutional investors are embracing a wide variety of quantitative strategies and planning to increase their allocations. Much as the recognition of beta as a driver of returns has empowered the rise of passive investing, the identification of so-called ‘alternative beta’ has led to an understanding of underlying drivers of return in hedge funds – which were once thought to be entirely alpha driven.
Accessing this ‘alternative beta’ involves isolating the systematic, non-manager driven component of returns available from common alternative investment strategies from the alpha generated by individual managers. Conceptually there is no difference between traditional beta and alternative beta, in that they both result from systematic exposures to some risk factor. Just as index investing rewards broad market exposure, so alternative beta will reward exposure to factors such as price momentum, simple carry strategies and the relative performance of attractively and unattractively valued securities.
Alternative beta can be captured using relatively straightforward, rules-based investment strategies in daily tradeable vehicles.
Equal risk weighting to a variety of hedge fund styles can help to control volatility and balance overall risk. Targeting the systematic returns of these alternative strategies has historically rendered little performance correlation with each other or indeed even more importantly with traditional investments in global stocks and bonds. The combination of these strategies in a single portfolio can be calibrated to target a given volatility profile and to seek to deliver a consistent return stream above cash that is independent of the direction of the markets.
We would argue this has taken on renewed significance in light of what would appear to be a market regime change – the reflation trade. If one key driver of portfolios, global bond returns, appears to be coming to the end of a 35 year bull run, then that poses no small portfolio construction challenge for investors. It has led many to pose the question – can lower volatility, well-diversified hedge fund like exposure make up the gap left by traditional long-only fixed income returns?
We would argue that exposure to alternative beta can provide a diversifying source of returns in a period where fixed income’s traditional characteristics may be compromised. Instead of reinvesting more in traditional fixed income, which is burdened by low yields and liquidity concerns, we think investors will increasingly look to alternative sources of less correlated returns. Put another way, in an environment where replacing maturing fixed income exposures at the same level of returns without going way out on the risk/liquidity spectrum has become next to impossible, re-allocation conversations are coming to the forefront. And as investors recognize that the diversification benefits of alternative beta are more and more available in cost efficient vehicles, the pendulum could be set to swing.
Learn more about alternative beta here.
Opinions and statements of market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These views described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. ETF shares are bought and sold throughout the day on an exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be sold or redeemed directly from a fund by Authorized Participants, in very large creation/redemption units. For all products, brokerage commissions will reduce returns.
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