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Return-seeking Alternative Risk Premia

July 2021

Previously, we’ve discussed Defensive ARP (Alternative Risk Premia), particularly as a bond alternative with yields close to their effective lower bounds. We round out that analysis by introducing our Core and Growth ARP portfolios. We also include a new section in this publication below, reviewing the performance of our ARP portfolios and highlighting any interesting observations on the broader Quantitative Investment Strategy (QIS) complex.

CIPAM Core & Growth

Our Core and Growth portfolios target a higher return profile and are constructed to offer an additional return-seeking option in the broader asset allocation process. Drawing on our large pool of available indices, the strategies are designed to contain a number of characteristics that increase their effectiveness over the medium- and long-term:

  1. Each portfolio contains uncorrelated neutral ARP factors that work to reduce volatility at the portfolio level
  2. Each portfolio also contains dedicated return-seeking factors that contribute performance to the portfolio
  3. Each of these return-seeking factors target different risk premia and as such are sources of uncorrelated alpha within the portfolio

Figure 1 compares the performance of these two ARP portfolios to MSCI World. We see that since 2017, the ARP portfolios generate consistent returns at much lower volatility. While MSCI World is capable of sharp rallies, it is also susceptible to acute drawdowns. This is even more evident when we look at specific 6-month periods over that time (Figure 2).

Given that both returns and volatility move around, it is important to compare risk-adjusted returns through time. The below table shows the returns, volatility and their ratio for 6-month windows starting in 2017.

The higher Sharpe ratios delivered by the two ARP portfolios make for a smoother ride through different market environments. This is in part due to the neutral factors dampening the volatility of the portfolio. This does not come at an outsized cost to returns, as the Core and Growth portfolios return 11.2% and 12.2% per annum respectively, compared to MSCI World at 14.2%.

CIPAM Core & CIPAM Growth offer a de-correlated, return-generating alternative to traditional equity and alternatives allocations. They can be used to replace beta or as an additional diversified source of returns.

Next month we’ll continue to look at alternative ways to introduce return-seeking portfolio blocks, with a focus on credit.

The Solutions Team

The Solutions team provides derivative overlay and risk management fiduciary services to Asset Owners and Managers in Australia. Our goal is to provide asset owners and managers with an experienced overlay advisory and execution service to improve portfolio outcomes and cost efficiency.

Important notice
Financial services provided by Challenger Investment Solutions Management Pty Ltd (ABN 63 130 035 353 AFSL 487354) (CIP Asset Management, CIPAM). The material in this document is general background information about Challenger’s Investment Solutions activities and is current at the date of this document. It is information given in summary form and does not purport to be complete. It is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any particular investor. These individual circumstances should be considered with professional advice when deciding if an investment is appropriate. Nothing in this document should be considered a solicitation, offer or invitation to buy, subscribe or sell any, or a recommendation of, financial products. All reasonable care has been taken to ensure that the facts stated and opinions given in this document are fair and accurate. To the maximum extent permitted by law, the recipient releases each member of the Challenger Limited group of companies, their directors, officers, employees, representatives and advisers from any liability (including, without limitation, in respect of direct, indirect or consequential loss or damage or loss or damage arising by negligence) arising in relation to any recipient relying on anything contained in or omitted from this document. Any forward looking statements included in this presentation involve subjective judgment and analysis and are subject to significant uncertainties, risks and contingencies, many of which are outside the control of, and are unknown to, Challenger. In particular, they speak only as of the date of these materials, and they are subject to significant regulatory, business, competitive and economic uncertainties and risks. Actual future events may vary materially from forward looking statements and assumptions on which those statements are based. Given these uncertainties, recipients are cautioned not to place undue reliance on such forward looking statements. Any past performance information provided in this presentation is not a reliable indication of future performance. This document is not audited.