Wednesday, July 15, 2020

A comparison between ARP, hedge funds, and real assets


The choice set in the alternative investment space has grown so investors need to think through the widening set of opportunities. The opportunities are not just based on strategies or risk factors but on the broad mechanism for delivery of strategies. 

The alternative space can be divided into real assets, hedge funds and alternative risk premia. There are other ways to categorize; however, this may be one helpful approach for discussion purposes. Real assets will represent direct investments in non-traditional assets such as private equity. Hedge funds represent managed liquid alternative, discretionary or systematic, strategies. Alternative risk premia (ARP) can be accessed total return index swaps or investments tied to specific risk premia or factor strategies.  

The stars in our table below represent which alternative, real, hedge fund, or ARP has an advantage for investors across a number of criteria. There can be wide dispersion within each category; however, we are providing some general observations on relative merits.

The correlation with equity market risk suggests the level of diversification that can be achieved through each category. Given the strategy focus of an alternative risk premium, there can be greater diversification benefit. The investor can choose a specific level of diversification that may not be achieved with a real asset or a hedge fund investment where the managers chooses the level of diversification.

The liquidity terms for an ARP swap may be superior to hedge funds and real assets. Hedge funds may not provide daily liquidity, and real assets such as private equity may be subject to less liquidity.  

ARP swaps based on indices of risk premia strategies or factors provide full transparency; albeit index terms will not change. Hedge funds may have limited transparency based on reporting requirements. Private equity may have known investments, although they are subject limited details.

Pricing is superior for ARP given values are usually posted every day. Real assets may not have daily pricing available and prices at the end of year for private equity may be subject to interpretation. Hedge fund pricing is sensitive to the liquidity of the underlying assets held in the portfolio.

The return and volatility rating for each category is complex. ARP have daily pricing which may make calculating return and risk straight forward, but these measures will be subject to significant noise based on daily variation. Return and risk will be highly variable based on the risk premia held. Return and risk are usually smoothed for real assets. Hedge funds will have less smoothing but will be subject to the fluctuations in net asset value.   



The choice of where investors will obtain their diversification faces a number of generalized trade-offs. ARP swaps will allow for more flexibility, transparency, and liquidity but places more of the management responsibility on the manager.

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