Alternative Risk Premia (ARP) funds passed their initial test during the correction in the last quarter of 2018, says Cambridge Associates.

Research by Cambridge Associates shows that Alternative Risk Premia (ARP) funds, which are a kind of hedge fund alternatives, returned -4% during the market correction in the last quarter of 2018. In contrast, equities returned -13.7%, and equity hedge funds returned -9.3%.

By this measure, ARP funds appear to have passed their first test.

ARP funds still to be fully tested

However, ARP funds need to be validated over longer test frames. Only then can they establish their worth as a viable asset class.

ARP funds seek to achieve higher returns by investing in risk premia that create pricing bias. Examples include size (small cap versus large caps), value (cheap versus expensive), and momentum (outperforming stocks continue to do so).

ARP funds for pensions

By adding ARP funds to its portfolio, a pension fund may diversify its returns and reduce risk. ARP funds can cheaply hedge funds and thereby generate cost savings. Fees on ARP funds are in the range of 0.5% to 1%. However, the “2-and-20” scale of fees is still prevalent in the hedge fund industry.

Back-testing of pension data by Cambridge Associates shows that adding a 30% component of ARP to a pension’s equity and bond portfolio generated a cumulative 37% over the past five years. However, these returns dropped to 35% if the 30% component was hedge funds instead of ARP.

“The potential for smoother returns, greater liquidity, and lower fees will be very appealing to pension funds if ARP funds can successfully deliver on those objectives over a full cycle,” said Trudi Boardman, Senior Investment Director at Cambridge Associates.

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