The Case for Alternative Risk Premia: Part 3

December 2024

This paper examines the case for diversified, market-neutral factor strategies as a way to strengthen institutional portfolios. These are systematic strategies that structure long and short positions to remove directional market exposure, so their returns depend on factor selection rather than the direction of equities or bonds. Because those returns tend to have low correlation with traditional assets, they can improve diversification and add resilience during difficult market conditions, without acting as a steady drag in normal periods. The paper groups the strategies into three areas: global macro factors traded through liquid futures, stock selection factors traded through individual equities, and corporate event strategies built around announced mergers. It shows how each behaves across a range of market environments, how they combine into a diversified portfolio, and how a modest allocation can affect a traditional 60/40 portfolio. It is written for institutional allocators, OCIOs, and consultants, and it frames its conclusions as analytical perspective grounded in a long historical simulation.

What This Paper Examines

• Why market-neutral factor strategies tend to have low correlation with equities and bonds.
• How factors group into macro, stock selection, and corporate event families, and why the distinctions matter.
• How each family behaves across favorable and stressed environments for equities, credit, government bonds, and inflation-protected bonds.
• How diversifying across factor families and asset classes can build resilience.
• How a modest allocation to a diversified factor sleeve can affect a traditional 60/40 portfolio.

Key Findings

• Market-neutral construction is what makes these returns diversifying. Structuring balanced long and short positions removes most directional market exposure, so returns depend on factor selection. As a result, they tend to have low correlation with equities and bonds.
• Diversifying across factor families and asset classes improves resilience. Value, momentum, and carry in macro markets, value, quality, and momentum in stocks, and merger-based event strategies tend to have low correlations with one another. Combining them spreads risk across independent return sources.
• These strategies can earn across market regimes, not only in stress. Unlike tail-hedge or insurance strategies that pay off only in crises and lose money otherwise, diversified factor strategies have historically earned returns in normal environments too. That means diversification does not come as a persistent drag on the portfolio.
• Implementation quality, not the published idea, is the differentiator. As the field has matured, generic implementations drawn straight from the academic literature tend to see their returns compressed by competition. Sustaining attractive returns requires sophisticated, hedge-fund-grade construction and ongoing enhancement.
• A modest allocation can improve a traditional portfolio’s risk profile. Reallocating part of a 60/40 portfolio to a diversified, market-neutral factor sleeve can lower overall portfolio risk and reduce drawdowns during stress, while keeping return potential intact.

The Authors

Deepak Gurnani, Founder and Chief Investment Officer

Deepak Gurnani is the Founder and Chief Investment Officer of Versor Investments. Deepak has three decades of experience in applying quantitative methods to uncover alpha across global equity markets. Over the past decade, he has focused on pioneering the use of AI and alternative data in equity investing.

Ludger Hentschel, Founding Partner, Investment Advisor

Ludger Hentschel joined Versor Investments as a Founding Partner and is based in New York. Ludger has over 20 years of experience in quantitative research and investing.

Disclaimer: Past performance is not necessarily indicative of future results. Not an offer to sell or a solicitation of any type with respect to any securities or financial products.

Methodology: The analysis groups systematic strategies into three areas. Global macro factors capture value, momentum, and carry across more than one hundred liquid futures contracts in equities, commodities, fixed income, and currencies. Stock selection factors capture value, quality, momentum, earnings quality, profitability, and analyst sentiment across roughly three thousand developed-market equities in the US, Canada, the UK, Japan, Australia, and Europe. Corporate event strategies trade around announced mergers in the US, Canada, the UK, and Europe. Each area is implemented market-neutral.

To study behavior across environments, the paper sorts quarterly returns for four asset-class proxies, global equities, government bonds, high-yield credit, and inflation-protected bonds, into five bins from worst to best, and compares the contemporaneous returns of each factor family. It then assembles an illustrative diversified portfolio that blends the three areas and compares a traditional 60/40 allocation with one that redirects a portion into the diversified factor sleeve. The historical simulation runs from January 2003 to September 2024.