Antifragile alternative risk premia portfolios - Not easy to structure

Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure , risk, and uncertainty.

The antifragile loves randomness and uncertainty, which also means— crucially—a love of errors, a certain class of errors. Antifragility has a singular property of allowing us to deal with the unknown, to do things without understanding them— and do them well.

By grasping the mechanisms of antifragility we can build a systematic and broad guide to nonpredictive decision making under uncertainty in business, politics, medicine, and life in general— anywhere the unknown preponderates, any situation in which there is randomness, unpredictability, opacity, or incomplete understanding of things.

From Antifragile: Things That Gain from Disorder by Nassim Taleb 

The value of factor investing has been well documented. A diversified portfolio of alternative risk premia can generate good returns with controlled risk, uncorrelated with traditional assets. Investors get paid for holding risks different than market beta. Yet the core, or primal, problem investors want to solve with alternative risk premia is very simple. How do you not only diversify but also protect a portfolio against left tail events?

The idea of trying to protect against left-tail events is a less colorful way of saying investors are looking for antifragile risk premia. I cannot say that there is such a thing as an antifragile premia. By definition, a risk premium is compensation for risk taken, but the behavior of risk premia will differ across market environments and the business cycle. Premia that do better when market risks are high are valuable. Hence, they will not receive higher stand-alone returns. 

Investors are now digging deeper into the characteristics of alternative risk premia to build diversified portfolios that tilt to specific risks or are structured for more downside protection. Some risk premia are pro-cyclical while others have pay-offs that may be more counter-cyclical. 

Some simple solutions in a fragile environment are costly. Buying puts is one possibility, but option premiums are costly. Switching from stocks to Treasury bonds has been a good diversification alternative since bonds serve as a flight-to-quality asset. However, holding bonds has become more expensive as yields have fallen. Now bonds that serve as the flight-to-quality asset have negative yields. 

Still, we classify some alternative risk premia as being antifragile-friendly.

Good for when there is expected fragility: 

• Non-predictive strategies like trend-following (time series, not cross-sectional) 
• Long volatility that will improve when volatility rises
• Non-carry strategies 
• Flight to safety/liquidity - Treasury bonds 

Good for when markets have reached maximum fragility: 

• Carry 
• Value
• Mean-reversion 
• Short volatility 
• Illiquidity 

While no single risk premia can be viewed as antifragile, combinations of alternative risk premia can be bundled into portfolios that perform better under market stress. This is an important area for further research, as it examines the properties of alternative risk premia under different market conditions.