Tuesday, February 19, 2019

Global Risk Premia - Long-term support across strategies and asset classes especially for trend and carry

What should you believe about global risk premia? There has been so much research on the topic across so many different sample periods and specifications that it is hard to draw strong conclusion if you are an investors. Now we have a new paper that can be classified as one of the definitive studies on the topic.  See "Global Factor Premiums"  by G Baltussen, L Swinkels, and P Van Vliet.  

Examining 24 global factor premiums across the major asset classes with a data set that spans 200 years the authors are able to provide a unified testing environment to provide some deep knowledge on the topic. Global risk premia are statistically significant and stand the test of time. 

However, their research also finds that these risk premia are not driven by market, downside, or macroeconomic risk which is not expected based current asset pricing theories. A premia is paid for risk taken, but what is the risk that investors are being paid to take if we cannot relate back to "bad times", the market, or some downside? This is an issue for much further discussion.

The authors look at trend (time series), momentum cross-sectional), value, carry, return seasonality, and betting against beta. These are analyzed against equity indices, bonds, commodities, and currencies for  total of 24 premia. They address the p-hacking problem but still find that there are a significant number of global risk premia that are clearly significant. The two risk premia that show the strongest significance and the most universal value are trend-following and carry followed by momentum. The significance of trend and carry risk premia applies to centuries of data.

The historical Sharpe ratios are highest for trend and carry when applied across the broad set of asset classes. Over the long-run, seasonality also serves as a strong risk premia. There is value with following global macro carry and trend strategies. 
This exhaustive and careful work supports the universal appeal for global risk premia albeit there is no guarantee that significant Sharpe ratios will be present during all periods. Further research is needed understand the why these strategies receive risk compensation. Nevertheless, a core strategy of trend and carry is fundamental to a strong performing diversified portfolio. 

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