Many investors look to alternative risk premia strategies for attractive returns and diversification benefits within their overall asset allocation. In contrast, many see valuations for traditional assets as stretched and have been disappointed by inconsistent hedge fund performance. As portfolio managers Josh Davis, Matt Dorsten and Graham Rennison explain, PIMCO’s Multi-Asset Alternative Risk Premia Strategy provides an efficient way to gain exposure to a diversified suite of alternative risk premia.
Q: What is PIMCO's Multi-Asset Alternative Risk Premia Strategy (MAARS)?
Davis: MAARS features a collection of well-known alternative risk premia strategies, such as value, carry, momentum and risk aversion, sourced across all major asset classes, including equities, rates, commodities and currencies. It is designed to be a true alternative: Unlike most of our peers, we control equity beta and duration at the underlying strategy and portfolio levels to ensure consistent diversification. We also follow a dynamic approach to risk allocation and employ valuation-based tilts, rather than the static risk-allocation approach used by most of our competitors.
PIMCO has deployed alternative risk premia strategies since the 1980s in a variety of hedge funds and other actively managed portfolios. We refer to them as “structural alpha,” and have written extensively about their use in our portfolios. (See "The Secret of Active Portfolio Management" by Mihir P. Worah and Ravi K. Mattu.) Along with top-down macro and bottom-up security selection, alternative risk premia have been a key driver of our alpha.
In short, MAARS is new, but the underlying strategies are not. MAARS combines these strategies, providing investors access to our best ideas in alternative risk premia in one efficient and comprehensive package.
Q: Why are investors embracing these strategies?
Dorsten: Alternative risk premia are getting mainstream attention because they can potentially deliver a meaningful boost to returns and provide portfolio diversification. With bond yields near historical lows and equities fully valued, investors globally are concerned that traditional asset returns are likely to underwhelm. Many see a widening gap between their official return targets and what they think markets are priced to deliver.
Alternative risk premia strategies are ideal for this environment as they can help bridge the gap without forcing investors to pay high fees or sacrifice liquidity. Moreover, as these strategies are long/short and have no directional exposures to any asset class on a systematic basis, they potentially are also highly diversifying.
Q: What is different about PIMCO MAARS?
Rennison: We think MAARS is a differentiated strategy that is quite complementary to those managed by some of our peers. In part, this is because MAARS, in several aspects, goes beyond the traditional premia associated with value, carry, momentum and volatility:
First, we are highly selective. We only include risk premia that have been proven to exist across multiple business cycles, possess a clear economic rationale, and are affirmed by extensive academic research. Another key consideration is liquidity. Every strategy in our opportunity set is tradable using highly liquid or exchange-traded instruments. We think selectivity is important, as these risk premia exist across most asset classes but not everywhere. We believe a “kitchen sink” approach, which allocates to every alternative risk premium without stringent screening criteria, is dangerous.
Second, our strategy suite is complementary. We emphasize our strength in fixed income, currencies and commodities by investing the bulk of the risk in non-equity-based alternative risk premia. In contrast, equity-based risk premia seem to dominate portfolio risk in strategies managed by many of our peers, with some allocating as much as 70% of the risk to equity-based strategies. In our view, a balanced allocation among risk premia, where no single asset class or premium dominates, is prudent, both from a return as well as a risk perspective.
Third, we have designed each strategy to seek near-zero correlations to both stock and bond markets by hedging out exposures to these markets at the strategy level. Despite the costs associated with hedging, we think this is critical to live up to the “alternative” label. In addition, we don’t want our strategy to depend on historical correlations among risk premia remaining steady for diversification benefits to be realized.
Finally, and what I think really sets us apart, is the attention to detail we have paid to strategy construction. As Josh pointed out, PIMCO has implemented and enhanced these strategies across a range of products for several decades. We think robustness of construction will play a big role when market conditions become less conducive. Strategies based simply on backtests without actual trading experience will find it hard to catch up.
Q: Why do you believe PIMCO has an edge in strategy design and implementation?
Dorsten: While managers may refer to the same risk premia, investors conducting due diligence will quickly discover that both strategy construction and implementation vary significantly across managers. Indeed, there is no industry consensus yet on the definitions of some of these risk premia, let alone how to capture them. This is likely to lead to significant dispersion in outcomes, which indeed has been the case thus far.
In designing our strategies, we have the benefit of years of experience and insights from across our entire investment platform. Our team of quantitative researchers, working closely with PIMCO’s global macro and sector specialists, has refined these strategies over time, further improving our models and implementation.
Execution also is key as these strategies are dynamic and frequent trading is necessary. PIMCO's size and product diversity potentially give us a sustainable “terms of trade” advantage in the form of the lowest possible execution costs. Furthermore, the broader trade flow at PIMCO allows us to mask our systematic-strategy trade flow, preventing trading counterparties from gaining implicit insight into our trading models.
Q: How are investors using these strategies?
Rennison: Two key themes seem to dominate. One is a focus on seeking higher returns by allocating to alternative risk premia strategies that target volatilities in the high single digits or greater. We anticipate these strategies will deliver meaningfully higher returns than those provided by traditional stocks and bonds.
As Matt highlighted earlier, we also see clients turning to these strategies as a source of portfolio diversification. Given these strategies are constructed using long/short portfolios that explicitly target market neutrality, we expect they will have low correlations with both equities and fixed income markets. This stands in contrast with many of our peers, whose strategies often convey significant equity beta, often accompanied by bond duration, and are therefore not a true alternative approach. For these reasons, some investors are using these strategies as an “enhanced diversifier” to complement core fixed income allocations.