Practical Applications of Sources of Return Dispersion in Alternative Risk Premia

Practical Applications

In Sources of Return Dispersion in Alternative Risk Premia from the Spring 2020 issue of The Journal of Alternative Investments, author David E. Kuenzi of AlphaSimplex Group identifies eight factors that drive differences in performance (i.e., return dispersion) among investment funds that use the same alternative risk premia (ARP) strategy. ARP strategies attempt to realize sustained returns that are not correlated with the underlying markets in which they invest. But even though each ARP strategy has a clear set of rules, there is significant return dispersion among different ARP funds that use the same strategy. The author says this happens because different fund managers implement the same strategy differently. He identifies eight specific drivers of such differences in implementation, and ranks them in order of importance. He then demonstrates that altering just two such factors can cause dramatic return dispersion.

Kuenzi says the most important drivers of differences in strategy implementation—and therefore, of return dispersion—are investment firms’ different histories, philosophies, and core competencies. He recommends that investors learn about the history and culture of each firm to gain an understanding of how its fund managers are likely to implement any ARP strategy.

TOPICS: Real assets/alternative investments/private equity, analysis of individual factors/risk premia, statistical methods, performance measurement