How would you briefly summarise the past five years, both with regards to your industry and your product?
The good news regarding our industry has been that clients have become increasingly sophisticated when it comes to judging investment managers’ claims of ‘alpha’, ie the manager skill element of the funds they buy. Many now know that a lot of the alpha that they used to be happy to pay 2/20 for in their hedge fund allocation is actually nothing more than ‘hidden beta’ – even if it is the kind of beta that cannot be generated with long-only investment techniques. This hidden beta we call “alternative risk premia” or “alternative beta”.
Hence, when I explain the risk premia offering now, it starts to feel like preaching to the converted: Because if implemented correctly, alternative risk premia offer valuable diversification into uncorrelated sources of return with complete transparency, daily liquidity and low costs. This message was much more difficult to get across more than 12 years ago when I started developing and investing in alternative risk premia.
What were the main factors behind the strong performance of the portfolio since launch?
The portfolio overall has performed broadly as expected, delivering a gross Sharpe Ratio of slightly above 1.0 and low correlation to equities and bonds over the five years. No single factor stands out regarding the performance contribution over the period, but avoiding drawdowns as much as possible was certainly a helpful element.
What was/were the major challenge(s) over the past five years?
The decisive challenge was of course to generate attractive returns with little correlation, which I am pleased to say, was successfully completed.
On a more general basis, a particular challenge was providing investors with a better understanding of certain crucial aspects: how alternative risk premia strategies actually generate returns, why they are inherently uncorrelated to traditional risk premia, and how a fair fee and compensation structure makes a clear distinction between genuine – highly-paid – alpha, and significantly cheaper beta, with the latter being what our strategy is all about. Today, investors understand this alternative risk premia value proposition and are embracing the offering.
What was the most successful development for the portfolio over the period since launch?
Initially, the portfolio was run on an investment bank platform over the first few years, which was used to execute trades and to access off-the-shelf alternative risk premia strategies. As the team expanded, GAM felt confident to take the whole operation to the next level. This means that now around 95% of all trades are self-executed, and we design the premia we invest in ourselves. This has been a smooth portfolio evolution because directly designing and trading individual premia is what my team and I had been doing for over 10 years before we joined GAM a few years ago. This evolution saves our investors implementation costs and ensures maximum cost efficiency and excellent quality of underlying strategies.
What environment is most beneficial for the strategy?
Our strategy benefits from the market showing clear momentum and an appreciation of value, plus, of course, non-distressed markets mean that in general carry strategies pay off.
Where are you and your team seeing the most attractive opportunities and why?
Our portfolio is broadly diversified across risk premia and across asset classes, and we do not endeavour to perform tactical market timing, for example by over- or underweighting positions based on their perceived attractiveness at a certain point in time. Our portfolio of risk premia strategies is well balanced against very different market environments.
Where do you see the downside / tail risks and how are you positioned to mitigate them?
Downside protection is built into our strategy through the focus on “expected drawdown” as the key risk measure in our portfolio construction. It is an in-house developed portfolio optimisation methodology that especially focuses on the far left part of the return distribution for the purpose of quantifying risk. While the focus remains on enhancing the risk/reward ratio, it is about avoiding and minimising losses rather than reducing volatility. This method focuses much more strongly on the preservation of capital, which proves particularly beneficial during turbulent market phases.
How do you see the risk premia industry develop over the next few years?
First of all, risk premia as an investment concept is here to stay as this has become a mainstream investment approach. Second, we expect to see higher sophistication among our investors as they learn more about this approach. Investors are going to demand even more from their providers, as they look for sustained performance edge, strong transparency, low implementation costs and proven experience in this field. This means that only the stronger players are likely to survive, while new players with no ‘live’ track record will have a hard time convincing investors to give them money. Investors have become savvy to the risk of believing overly optimistic back tests and now prefer to trust actual historical performance like ours.
Why is a ‘live’ track record so important?
A real track record proves you have experience and it makes your success (or lack thereof) transparent. Regrettably, it has become a common characteristic of the financial industry that where there isn’t a real track record, one is produced artificially as a back test. This means that a back test with historic price data is performed with a model that was not traded live. Almost needless to say, these types of back-testing models very rarely pass the litmus test of real trading – our own experience in this field is supported by a recent study that shows exactly that risk.
At GAM, we are in the fortunate position to have a five-year track record as well as a team that is considered to be a worldwide pioneer in this sector since 2004, with in total now a live track record of more than 12 years in designing, implementing and executing alternative beta strategies.