When 2020 began, one of the hottest businesses on Wall Street was selling exotic quant trades known as alternative risk premia. These strategies were marketed as diversifying, loved by hedge funds and priced cheaply.
Then Covid-19 happened.
As the pandemic gripped markets, strategies commonly used in the ARP mix from stock trend-following to volatility insurance, were whipped around like never before. That meant these funds largely failed to live up to their uncorrelated hype in the sell-off, and were then left behind by the ferocious rebound in risk.
Eight months into the year, Societe Generale SA’s ARP index is down 14%. A Eurekahedge benchmark tracking indexes sold by investment banks has lost 7%. Managers including GAM Systematic and AQR Capital Management have seen their assets in such funds at least halve in 2020.
The fear is that ARP funds, with an estimated $200 billion overall, have either became too popular for their own good, or are ill-suited for a market shifting between meltdown and melt-up at a record pace.
“Allocators have been wondering whether these things really work,” said Antti Suhonen, senior adviser at MJ Hudson Allenbridge in London, which offers investment advice to institutions. “It’s true this year has seen very exceptional moves. But even so the performance has been disappointing.”
ARP products combine a diverse bunch of trades, often tried-and-tested ideas beloved by quants such as the tendency for cheap stocks to outperform in the long run or for short-term commodity futures to trade below long-term ones. The composition of funds and their returns vary vastly, but managers can point to a few unifying trends that have been a drag on performance in 2020.
The March turmoil upended the normal trading patterns these strategies rely on. Then the fast market recovery whipsawed trend-following systems and forced systematic models to dial back market exposures and miss out on gains.
At the same time, many popular factors used by these funds -- such as value and foreign-exchange carry -- failed to rebound along with stock benchmarks.
“The recovery depended on whether you were in those main long risk categories of liquid equities and fixed income,” said Anthony Lawler, head of GAM Systematic, which oversees about $3 billion. “ARP by and large are not in those things.”