Practical Applications of Business Cycle–Related Timing of Alternative Risk Premia Strategies

Abstract

Practical Applications In Business Cycle–Related Timing of Alternative Risk Premia Strategies, from the Spring 2020 issue of The Journal of Alternative Investments, Bernd Scherer and Matthias Apel relate how they developed a business cycle model to explore its predictive power in a tactical allocation framework. They created an aggregate of economic indicators that identifies economic regimes in order to determine the sensitivities of a host of risk premia strategies across various business cycle phases. Many of these sensitivities, measured as conditional Sharpe ratios, are statistically different from their unconditional, overall risk-adjusted returns. During each regime, a long–short tactical overlay strategy takes a long position in the four alternative risk premia strategies with the highest Sharpe ratios and shorts the four with the lowest. The authors show that the overlay strategy improves the performance of a risk-parity portfolio and provide evidence that the observed return patterns are not a beta-driven result. While their primary interest lies within a universe of investable alternative risk premia strategies, cross-validation tests also applied the model within three additional investment universes: global asset classes, smart betas, and Fama–French risk factors.