Alternative risk premia match well versus hedge funds

What is a hedge fund? From an investment and risk perspective, a hedge fund is a combination of factor styles and risk premia formed within an investment fund. There may be skill through the generation of unique returns or alpha, but as investors become better at decomposing risk factors, it becomes more apparent that hedge funds are often just a combination or bundle of these risk factors including carry, trend, momentum, value, and volatility across the set of asset classes of equity, rates, currency, credit, and commodities. 

Some hedge funds specialize in a style or asset class. Some hedge fund managers are discretionary and others are systematic. Most can be described through alternative risk premia (ARP) bank swaps which are total return swaps linked to an index that is associated with a well-defined risk factor. It is an alternative way of accessing risk factors. It does not mean that the bank ARPs are better or have special skills, and it does not mean that good hedge funds are not available. It is just another way of investing in risk factors. 

The folks at Premia Labs, the bank swap data provider, have compared a bundle ARP swaps against the SPX and HFR equity hedge fund index and find that a global cross-sectional, equity multi-factor, and global trend ARPs performed well during the first quarter. Additionally, when focused style risk factors are compared with  hedge funds indices, they have provided better returns for the first quarter of 2020.

The cross-asset trend and merger arbitrage ARP indices did better than comparable HFR indices. The outperformance may be caused by the index construction. It can also be caused by what may be a fee advantage with doing the total return swap which does not charge a management and incentive fee. At the least, ARPs returns should be compared with similar styled hedge funds. For example, the choice set for trend-followers should include not just a representative sample of hedge funds but a set of available ARP trend swaps. 

The search for diversification and return generation should be broadened during these crisis times to include liquid bank swap products. Bank risk has increased but so has the risk of hedge fund illiquidity and failure. The delivery choice set for any risk exposure should be maximized and then assessed to find the best ways to access risks.