Use of Derivatives in Asset Management
EDHEC-Risk's research on the use of derivative instruments in asset management has encompassed both the equity and fixed-income classes and has shown how derivatives can be used for active management of asset allocation decisions. Among the research results are evidence that derivatives can be used to generate and deliver abnormal performance that can be packaged within a core-satellite approach to portfolio management; that option portfolios can be used to enhance the performance of tactical asset allocation programmes; and that fixed-income derivatives offer significant risk reduction benefits in an asset-liability management context.
The following research in this area has been sponsored by Eurex:
- "Portable Alpha and Portable Beta Strategies in the Euro Zone - Implementing Active Asset Allocation Decisions using Equity Index Options and Futures"
Noël Amenc, Philippe Malaise, Lionel Martellini, Daphne Sfeir
October 2003While stock picking strategies are in principle meant to exploit evidence of predictability in individual stock specific risk, most equity managers, as a result of their bottom-up security selection decisions, often end up making discretionary, and most of the time unintended, bets on market, sector and style returns as much as they make bets on individual stock returns. This paper shows how portfolio managers in the Euro-zone can benefit from using derivatives markets to actively manage their asset allocation decisions in a systematic manner. Using a robust econometric process based on a non-linear multi-factor thick and recursive modeling approach, we report statistically and economically significant evidence of predictability in Dow Jones EURO STOXX 50 excess return. These econometric forecasts can be turned into active portfolio decisions and implemented via Eurex index futures to generate active asset allocation portable alpha benefits. We also show that adding active sector rotation decisions to asset allocation decisions allows one to significantly lower the portfolio volatility as a result of the benefits of bet diversification: We finally explain how active portfolio managers can benefit from using suitably designed Eurex option strategies as portable beta vehicles. In particular, option portfolios can be used to enhance the performance of tactical asset allocation programs by consistently adding value during the periods of low volatility when timing strategies are known to perform rather poorly. The benefits of active asset allocation decisions reported in this paper originate from the combination of a robust econometric and portfolio process on the one hand, and an efficient trading of low cost investible products such as Eurex index futures and options on the other hand. This strongly suggests that most long-short managers could use a similar methodology to enhance the performance of their portfolios without having to rely on the alleged superior performance of any specific predictive model.
- "From Delivering to the Packaging of Alpha - Illustration from Active Bond Portfolio Management: Using Fixed-Income Derivatives to design Hedge Fund Type Offerings that better fit Investors' Needs"
Noël Amenc, Philippe Malaise, Lionel Martellini
2005This paper emphasizes the need for the hedge fund industry to adopt a consumer (investor)-driven approach, as opposed to the current producer (manager) perspective, and calls for the emergence of new types of offering with characteristics better suited to the needs of institutional investors. Using active bond portfolio management as an example, we present evidence that derivatives can be used by managers not only for generating and delivering abnormal performance, but also for packaging such performance in a form that is consistent with the modern core-satellite approach to institutional portfolio management, for which we explore both a standard static version and also a dynamic extension allowing for dissymmetric control of active management risk.
- "Derivatives Strategies for Bond Portfolios"
Felix Goltz, Lionel Martellini, Volker Ziemann
2006This paper examines how standard exchange-traded fixed-income derivatives (futures and options on futures contracts) can be included in a sound risk and asset management process so as to improve risk and return performance characteristics of managed portfolios. The results show that the non-linear character of the returns on protective option strategies offers appealing risk reduction properties in the pure asset management context. Consequently, such strategies should optimally receive a significant allocation, especially when investors are concerned with minimising extreme risks. In an asset liability management context, the paper also shows that fixed-income derivatives in general, and recently launched long-term futures contracts in particular, offer significant shortfall risk reduction benefits. These results have potentially significant implications in the context of an increased focus on matching liability portfolios.
