Alternative risk premia - Obtaining diversity for both left and right tail events

Alternative risk premia (ARP) strategies and risk factors can be modeled and structured to provide return profiles that are significantly different from traditional assets. Given the variety of ARPs available, investors can create portfolios that have different performance and risk characteristics than what can be generated from traditional assets. Additionally, all ARP do not behave the same in up and down markets. 

ARPs can be chosen based on their expected return performance in the either the left or righthand tail of the market return distribution. Hence, investors can tilt their risk premia exposure based on their subjective expectations for market returns. For example, if there is a view that future returns are biased downward, an investor should overweight more exposure to cross-asset trend and momentum, commodity backwardation, and volatility curve premia. Alternatively, if there is a bias to a positive tail event, investors can choose ARP that have a performance bias to up markets. 

If you have a market view, why not just change the market exposure and not focus on ARP? It is a relevant question, yet in an uncertain world, the diversification value with variable returns conditional on market direction may actually lead to greater improvement in the overall portfolio Sharpe ratio. Lower strategy Sharpe ratios when coupled with lower correlation to the market may actually lead to increased overall portfolio efficiency.

See: Sharpe indifference curves and the power of diversification - Fundamental to the strategy approval process