background swath


Risk Premia Strategies – Beta Overlay 2.0?

  • Contributors:
  • David G. Eichhorn, CFA
shutterstock 266541431
The advent of investable risk premia indices brings beta overlay to a new level. These tools allow investors to adjust the pre-packaged factor weights of traditional asset classes toward a different weighting scheme based on priced factors and investors’ preferences.

Portable Alpha

For some time now, investors have recognized that separating alpha and beta can be desirable. Because alpha is not equally accessible in all markets, investors will pursue alpha in markets they believe provide attractive opportunities. When this quest for alpha results in undesirable beta exposures, an overlay may be deployed to bring the portfolio back in line. Portable alpha (or portable beta for that matter) is born!

When we begin porting beta, the natural question is: “To what target?” Investors generally start by reminding themselves what the beta portfolio was intended to do in the first place: provide efficient, market-based, risk-adjusted return. In a simple, one-factor world, exposure to the market portfolio is sufficient. In a multi-factor world, however, the answer is less clear. Equilibrium capital market theory suggests that the market portfolio provides an optimal risk/return package, at least so long as the investor is similar to the marginal investor that is setting the market price of risk.

But consider this: If investors can decompose the underlying “priced factors” of various asset classes and investment strategies, then they can potentially build more desirable (e.g., higher Sharpe ratio) portfolios from the markets’ fundamental primitive components. In the mindset of so-called “risk-premia” investing (and the various other monikers by which these strategies are known), many of the underlying priced factors might be better described as concepts or investment strategies rather than asset classes or fundamental exposures; examples would include value factors, momentum factors, carry patterns/term structures, etc.

Exhibit-1-Different-PersepectiveTraditional asset classes offer a somewhat random pre-packaging of the fundamental priced factors. It is, of course, possible that this pre-packaging results in the preferred risk-return combination when compared to building a portfolio of priced factors from the ground up… but it may not. Risk premia strategies—i.e., Beta Overlay 2.0—may be the new frontier of porting to a decidedly different concept of “beta.”

While not a new concept, risk premia investing is on the verge of being (re-)born. The combination of (1) the increasing challenge to meet return objectives, (2) technology-enabled ways to identify risk factors, and (3) derivative strategies designed to deliver isolated risk premia are just a few of the reasons for increased innovation in this area. I’m planning a few more posts on this topic in the near future. In the meantime, please feel free to reach out to discuss this topic directly.

Download the PDF

To download a PDF version, please click here.

Disclaimer: By accepting this material, you acknowledge, understand and accept the following:

This material has been prepared by NISA Investment Advisors, LLC (“NISA”). This material is subject to change without notice. This document is for information and illustrative purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation. This information is provided with the understanding that with respect to the material provided herein (i) NISA is not acting in a fiduciary or advisory capacity under any contract with you, or any applicable law or regulation, (ii) that you will make your own independent decision with respect to any course of action in connection herewith, as to whether such course of action is appropriate or proper based on your own judgment and your specific circumstances and objectives, (iii) that you are capable of understanding and assessing the merits of a course of action and evaluating investment risks independently, and (iv) to the extent you are acting with respect to an ERISA plan, you are deemed to represent to NISA that you qualify and shall be treated as an independent fiduciary for purposes of applicable regulation. NISA does not purport to and does not, in any fashion, provide tax, accounting, actuarial, recordkeeping, legal, broker/dealer or any related services. You should consult your advisors with respect to these areas and the material presented herein. You may not rely on the material contained herein. NISA shall not have any liability for any damages of any kind whatsoever relating to this material. No part of this document may be reproduced in any manner, in whole or in part, without the written permission of NISA except for your internal use. This material is being provided to you at no cost and any fees paid by you to NISA are solely for the provision of investment management services pursuant to a written agreement. All of the foregoing statements apply regardless of (i) whether you now currently or may in the future become a client of NISA and (ii) the terms contained in any applicable investment management agreement or similar contract between you and NISA.

Agree to Terms

Please review and accept the following to proceed. I have read and agree to the Terms of Use, Disclaimer, PSRX Disclaimer and Privacy Policy. I am either (i) an investment professional and an employee of an institutional investor, or a consultant to an institutional investor, or (ii) an employee of, or a student in, an institution of higher learning and I am involved in the study, research or teaching of subjects related to investments, finance, or economics. I reside in the United States or Canada. I understand that the information is not and should not be regarded as investment advice or as a recommendation regarding a course of action. By clicking “Accept” below, you hereby acknowledge, understand and accept the foregoing.