Risk Premium
Definition
A risk premium is the additional return an investor expects to earn for taking on a risky investment compared to a risk-free asset (typically short-term U.S. Treasury bills). It compensates investors for uncertainties such as market volatility, credit risk, illiquidity, and other potential losses.
Common types include the equity risk premium, credit risk premium, illiquidity premium, and term premium (related to holding longer-duration bonds).
Why It Matters to Investors
- Forms the foundation of modern asset pricing
- Helps justify higher expected returns from riskier assets
- Guides allocation decisions across equities, bonds, and alternatives
- Can vary across time depending on macro conditions, sentiment, and liquidity
- Understanding which risks are rewarded, and when, is critical to long-term performance
The TiltFolio View
Both TiltFolio systems are designed to pursue risk premia, but through different approaches. TiltFolio Adaptive's system is designed to pursue risk premia when conditions are favorable and sidestep them when they are not. Rather than accept risk passively (as traditional buy-and-hold portfolios do), the system actively adjusts allocations based on market regime. This trend-following approach aims to capture risk premia in "risk-on" environments, such as rising equity or credit markets, while preserving capital in "risk-off" regimes by moving into safer assets like Treasury bonds or cash. Importantly, the system is not constrained by arbitrary diversification rules and can go to 100% cash if no asset class offers an attractive risk-adjusted profile.
TiltFolio Balanced pursues risk premia through strategic diversification, maintaining consistent exposure to equity risk premium (30% stocks), bond risk premium (50% bonds), and inflation hedging (20% gold). This approach accepts risk premia passively but balances them across different asset classes to manage overall portfolio risk.
Both systems aim to capture risk premia: TiltFolio Adaptive through dynamic rotation and TiltFolio Balanced through strategic diversification.
Real-World Application
• An investor expects higher long-term returns from stocks than bonds due to the equity risk premium
• A credit fund targets the spread between high-yield bonds and Treasuries as a source of income
• A pension fund allocates to private equity seeking illiquidity and complexity premiums