Can Alpha be Captured by Risk Premia?

Jan 23, 2013

Accessing risk premia through the use of passive or index-based portfolios has been gaining momentum in recent years. While there is a vast decades-old literature on systematic factors, or what we refer to here as risk premia, it is only recently that institutional investors have accepted the notion of accessing them passively. As the number of risk premia options have proliferated, these risk premia strategies are beginning to form a third and separate category of return, sandwiched between traditional alpha and beta.

Can risk premia subsume some of what has traditionally ascribed to as alpha? And in a related vein, should risk premia be viewed as a replacement for existing passive beta investments or active mandates? Prior research at MSCI has shown that, relative to a market cap weighted allocation; risk premia can offer improvements in return, volatility, and/or risk-adjusted return. Empirical evidence supports that they can be considered as potential substitutes for the passive beta component.