Alternative risk premia breaks through in Asia

Until recently, fund managers in Asia that talked about alternative risk premia (ARP) spoke mostly about Japan and Australia, rarely about the rest of the region and almost never about China. There, any such plans were usually described as work in progress.

That began to change last year, with fund houses such as Ping An of China Asset Management (Hong Kong) launching in the sector. There have been some wobbles in the performance of ARP globally, but approaching the middle of 2019, executives are once again effusive about the sector.

A minority of pension funds and other institutions in Asia are users of risk premia, and investment managers face an ongoing task to convince investors the strategy has a place in a well-diversified portfolio. But it looks like they are succeeding.

JP Morgan’s 2019 Institutional Investor Survey shows Asia-Pacific investors are on track to become the most avid fans of ARP: 32% were already invested in the strategy in 2018 and a remarkable 21% are planning to do so for the first time this year.

The resulting 53% share of ARP users in Asia-Pacific would put the region above the expected total allocation by investors in Europe, the Middle East and Africa (50%) and leave peers in the Americas trailing well behind (32%).

That’s one reason for firms to consider their ARP plans in Asia, and in China in particular. But there are others too.

For a start, investors in the region have a strong home bias. So if managers want to be active in the sector they will need to offer products based on Asian underlyings.

Creating such local products also provides an opportunity to tap the yield carry on offer, given Asia remains one region where basic interest rates are relatively high. For instance, China’s benchmark 10-year bonds yield 3.3% – a full percentage point above 10-year US Treasuries and far higher than other developed market sovereign debt. Such opportunities give ARP providers the room to go long on Asia or China fixed income while taking a short position on developed market bonds and credit.  

In China, especially, ARP investors have a chance to exploit mispricing in the nation’s huge bond and equity markets arising from the dominant role of retail investors, who are less sophisticated than professional financiers and tend to follow the crowd. Retail investors account for 80% of turnover in equities but reap only a tenth of returns, for example, according to a study by Shenzhen International Exchange in 2017.

And recent regulatory changes should also help funds venturing into the space. In January, the China Securities Regulatory Commission proposed to relax the rules governing trading in mainland-listed futures by offshore investors. The relaxation will help offshore managers construct long-short portfolios of Chinese assets.

The addition of Chinese assets to global benchmarks such as MSCI’s and the Bloomberg Barclays Global Aggregate bond index can also be expected to improve disclosure from issuers, which in turn will improve the quality of data – an area that has been a stumbling block for systematic strategies of this type before now.

Lastly, Asia’s pension funds – big potential users of ARP – are growing. A list of the top pension funds globally compiled by Willis Towers Watson has seen three new entrants from Asia’s emerging markets to the top 20 in recent years.

Plenty of investors will remain to be convinced. But the sector in Asia beyond Australia and Japan is showing signs of coming to life. First-movers that are able to fine tune their models and build successful strategies stand to reap big rewards.