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When to Carry and When to Avoid Risk Premia

Top 5 of the Week of October 15th

For Bloomberg, Matt Levine discusses arbitrary U.S. security laws in our Top 5 this week. Wesley Gray, PhD, writing for Alpha Architect reveals what momentum and value investing have in common. And Nicolas Rabener from Factor Research considers the use of liquid alternatives.

Mark Rzepczynski, on his blog, covers when to avoid risk premia. And for Newfound Research, Corey Hoffstein examines trend equity strategies…


U.S. Investor Arbitrations

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  • The U.S. securities law sets limitations on individuals’ investing practices, while others, who are accredited can invest in any private placements they wish
  • Back in 1982, when the rules were put in place, only 1.5 million households were accredited investors, now 16 million are
  • Being accredited is not the same as automatically being wealthy or sophisticated enough investors to have the time to conduct due-diligence on privately held investment opportunities—earning them the right to be swindled too

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Two Peas in a Pod

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  • The premise of momentum is fairly simple—investors should only buy winners—but like value investing, the execution is not easy
  • Many investors are concerned that transaction costs can destroy momentum profits, but this isn’t the case—though capacity is limited
  • If measured by the ETF market it hasn’t yet become too crowded either and it will continue to work well into the future due to fundamental risk and costly arbitrage

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Liquid Disruption—Or Not?

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  • Liquid alternatives are changing the hedge fund industry by acting as typical hedge fund strategies in a mutual fund design with daily liquidity
  • As they charge less than classic hedge funds and come with no performance fees, liquid alternatives were, however, expected to be more disruptive than they have
  • Since 2013 though, data shows that liquid alternatives have been delayed at around $350 billion in AUM

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When to Carry and When to Avoid Risk Premia

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  • One of the biggest problems with alternative risk premia is not just working out if they are actually real, but how they change through time
  • Given their time variance and macro factor associations, tilting exposure based on existing or future market states could be possible
  • Or at least avoid carrying alternative risk premia during points when forecasted returns are predicted to be lower

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An Active Trend Strategy

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  • Trend equity is an active approach that looks to expose investors to equity risk premium while reducing the shock of harsh and lengthy drawdowns
  • The approach seeks to do this by combining exposure to equities together with a convex payoff structure classically shown by trend-following strategies
  • Despite possible drawbacks (including potentially “whipsaw events,” a lack of possible hedging, and extra costs), trend-following equity could be a useful diversifier in most classic portfolios

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Top 5 of the Week is a summarized collection of financial investment articles that we like and think you might like too. Having written thousands of pages of equity strategy and company research between us, we understand the allure of the ever-changing world of finance. Investing is an art form—and like everything, something you can work on and improve at. There are some excellent writers out there on the finance web, some offer a running commentary on today’s market, some are doing research, some have tips on how to Become a Better Investor, and some just lift the cloud of fog behind a lot of financial jargon. Each week we will keep you up to date with the top 5 articles worthy of your attention.


 

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