The lower the credit, the higher the premium 3. Equity premium: The equity risk premium has averaged about three or four per cent per annum for over one hundred years 4. Property premium: Property has paid a long-term premium above cash. The key words with all these premia are ‘averaged’ and ‘long-term’. While the premia exist and are real, there is a frightening ride associated with them over time. Chart 1 shows that equities have displayed a historic tendency going back over 100 years to deliver returns of negative 30 per cent and up to negative 50 per cent in one year out of seven. Property , cre dit an d equity risk premia As stated previously, the asset classes of credit, property and equities all rely on a similar underlying risk factor. When a company decides on its capital structure, it decides on how much equity to issue versus credit (bonds).

Investors rightly view owning equity as riskier than owning credit. This is because in the event of liquidation, bond holders receive their money back before equity holders. The key point though is that while owning the credit is less risky, it is the same risk – both are dependent on the earnings of the company. In addition, if, in an attempt to stave off bankruptcy, the company downsizes and reduces its need for office space, pressure is put on property prices. Thus, equity, credit and property are exposed to the same risk factor and share the same risk premium through changes in corporate earnings – an issue that has been highlighted in recent market conditions. Alternative premia In addition to mainstream premia there are other alternative premia that are also systematic payments of a premium for the transfer of risk. Another term for alternative premia is ‘alternative beta’.

Alternative beta/premia are any sources of return that are able to be replicated in a systematic and transparent manner – that is, insurancelike payments for taking risk – and that currently lie outside the mainstream asset classes. Growing deman d for alternative beta The credit crisis of 2008 and its fallout is likely to give significant impetus to ‘alternative beta’ strategies as investors recognise that they have been too reliant on the common sources of risk premia in mainstream asset classes.

In addition, the crisis has pushed expected risk premia of all forms to abnormally high levels, and the post-crisis, more regulated, environment will likely offer higher rewards to investors who focus on risk premia-based strategies. While hedge funds have traditionally provided access to a range of alternative risk premia, a growing number of investment managers believe that charging four percent per annum for exposure to what is essentially a risk premium is excessive. They seek access to alternative premia/beta at more cost- effective and transparent levels. Two candidates for efficient sources of non-traditional premia are the volatility and the currency carry premia.