Exchange-Traded Funds
Noël Amenc, Felix Goltz, Adina Grigoriu, David Schröder The EDHEC European ETF Survey 2009 presents the results of a comprehensive survey of 360 institutional investors and private wealth managers conducted in January and February 2009. It also provides an overview of the ETF market and of the mechanisms behind ETFs, and shows how advanced techniques involving dynamic allocation strategies can be carried out with ETFs, in particular to implement the beneficial core-satellite approach to investment. More...
18/06/09
Institutional Investment
Samuel Sender In 2003, the pension fund industry was severely affected by the steep fall in equity prices and the fall in interest rates. This fall and its consequences led to broad regulatory changes and spurred work on asset and liability management theory and techniques. But it seems that these new regulations and techniques have not enabled the pension fund industry to weather the current return of the perfect storm? This study examines recent publications and looks into the reasons for the fall in funding ratios. More...
15/05/09
Institutional Investment
Noël Amenc, Lionel Martellini, Samuel Sender This study analyses the impact of prudential and accounting constraints
on the asset-liability management (ALM) of European pension funds in
the Netherlands, the UK, Germany, and Switzerland. More...
04/05/09
Asset-Liability Management
Lionel Martellini, Vincent Milhau The recent pension crisis has triggered a
fierce debate in most developed countries between advocates of a tighter regulation designed to provide explicit incentives for pension funds to increase their focus on risk management, and those arguing that imposing short-term funding constraints and solvency requirements on such long-term investors would only increase the cost of pension financing. We analyse this question in the context of a formal continuous-time dynamic asset allocation model for an investor facing liability commitments subject to inflation and interest rate risks. In an empirical exercise, we find that the presence of short-term funding ratio constraints indeed involves a positive welfare cost, but that cost is not found to be prohibitive for reasonable parameter values. More...
24/04/09
Business Analysis
Abraham Lioui An in-depth study of the short-selling market calls into question both the reasons for the decision to ban short selling and the prejudices that weigh on those who short. According to recently published data (for the United States in particular), a large majority of short sellers are market makers who are hedging their bets on the options markets. They were not affected by the ban, which means that those who were using options to take synthetic short positions continued to do so. The others involved in short selling are mainly hedge funds. More...
24/04/09
Asset Management
The EDHEC European Investment Practices Survey 2008 (EDHEC 2008) sheds light on current practices in the industry and compares these practices with the recent state of the art as described in the investment literature.
The results of the survey show that the industry does not fully exploit a number of proven portfolio optimisation techniques that research has made readily available, such as management of extreme risks, improved covariance
estimation or Bayesian and resampling techniques.
We called for reactions to these results; the objective was to get feedback from
the European industry on the results of the survey. This feedback seems important to us for two reasons. First, we would like to know how the results of the survey and their usefulness are perceived by industry practitioners. Second, we are interested in explanations and perspective on our results. More...
31/03/09
Alternative Investments
This paper presents an empirical analysis
of the benefits of alternative forms of
investment strategies from an assetliability
management perspective. Using a vector error correction model (VECM)
that explicitly distinguishes between short-term
and long-term dynamics in the joint
distribution of asset returns and inflation,
we identify the presence of long-term
cointegration relationships between the
return on typical pension fund liabilities
and the return of various traditional and
alternative asset classes. More...
20/03/09
Indices
This paper serves as background literature
to the new index and outlines its features
and characteristics. First, the importance
and the specific characteristics of the
real estate market as well as the available
real estate investment vehicles are
presented. Second, the challenges and
problems involved in real estate indexing
are discussed. Third, the French real estate
market, as the market underlying the
index, is described. Fourth, the construction
methodology of and the rationale for
the EDHEC IEIF Commercial Property
(France) Index are discussed in more detail.
Fifth and last, this paper provides a set
of empirical tests of the properties of the
index. More...
11/03/09
Alternative Investments
This paper analyses twelve years of data on EDHEC Alternative Indexes for different hedge fund strategies to provide some perspective on their performance. The extraordinary events of 2008 were not without an impact
on hedge fund returns. Funds of hedge funds lost 17% in 2008, posting their worst annual returns since we began keeping records in 1997. Hedge fund investments lost value across the board. Except for CTAs and Short Sellers, all strategies posted their worst losses in 2008. Even after the impact of a calamitous year, half the strategies still post cumulative returns above 100% for the past ten years, that is, a compound annual return above 7%. More...
17/02/09
Alternative Investments
For more than seventeen years, Bernard Madoff operated what was viewed as one of the most successful investment strategies in the world. This strategy ultimately collapsed in December 2008 in what financial experts are calling one of the most detrimental Ponzi schemes in history. Many large and otherwise sophisticated bankers, hedge funds, and funds of funds have been hit by his alleged fraud. In this paper, we review some of the red flags that any operational due diligence and quantitative analysis should have identified as a concern before investing. We highlight some of the salient operational
features common to best-of-breed hedge funds, features that were clearly missing from Madoff’s operations. More...
09/02/09
Alternative Investments
Felix Goltz, David Schröder Like any investors, investors in hedge funds are naturally interested in knowing how hedge fund managers allocate their initial investment, and whether this allocation yields positive returns or not. It is not only information on past investment returns that is of particular interest; prospects for future gains or losses are relevant to investors as well. Yet, unlike mutual funds, hedge funds are reluctant to provide detailed information on their investment portfolios. Since many hedge funds use highly speculative investment strategies, fund managers fear that a thorough disclosure of their portfolio holdings would significantly decrease their chances of winning their bets, and thereby reduce investors' returns. But incomplete disclosure can have some undesirable side effects. More...
05/02/09
Regulation
The financial crisis has put great pressure on banks and led to a number of emergency measures intended to restore confidence in the banking system: tentative changes to accounting standards, recapitalisation of the banking industry, and higher capital requirements. Each measure targets a specific concern that has arisen during the crisis. Governments and regulators, however, have yet to deal with one of the essential causes of systemic risk: the inflexibility of prudential regulation for banking. As it happens, a single minor change would make it possible to restore much of the confidence in the
banking sector without requiring any capital injections in the short term: acknowledging that banking capital ratios fall during downturns would have made most of the injections of public funds unnecessary. Making this change today would give governments far more room to support the real economy. More...
30/01/09
Regulation
A "call for reaction" was sent by EDHEC to international institutional investors and asset managers to compare investor views of the amendments to the IAS39 and IFRS 7 standards not just with the conclusions of an initial EDHEC study ("The Fair Value Controversy: Ignoring the Real Issue"), but also with the ambitions of these reforms prepared and adopted in great haste.
The call for reaction received more than 800 responses and represents the first international survey on the relevance of the reforms carried out by the IASB under pressure from the European Commission. The results of this study correspond to EDHEC’s initial arguments. Fewer than a quarter of the respondents believe that these amendments are necessary and well suited to resolving the problems of bank solvency. Moreover, three-quarters of respondents believe that they are likely to lead to new problems. More...
23/01/09
Performance
The results of this EDHEC position paper show that none of the sixty-two funds in the sample, covering various investment zones, manage to produce both positive and significant alpha (outperformance) over a six-year period and that the few significant alpha values are negative. Moreover, most of the funds generate negative, non-significant alpha. The study also shows that alpha values estimated over one year change greatly from one year to the next. The use of a period of various lengths shows that results can vary greatly from one length to another. More...
20/01/09
Transaction Cost Analysis
This publication covers a broad range of material related to TCA and best execution. As understanding transaction costs is crucial to properly assessing the quality of implementation decisions and complying with the best execution obligation in the post-MiFID environment, it provides a state of the art of TCA fundamentals, undertakes a critical review of existing post-trade TCA techniques, and defines a new and complete approach More...
15/01/09
Private Wealth Management
With the great economic growth of the past decade, private wealth management
has become a very profitable business for banks worldwide. As a result, more
and more asset management firms have jumped into the fray and competition has increased steadily. These industry changes have led to renewed attempts to improve client relationships and to develop tools and methods to enhance advisor effectiveness. Catering to the client’s specific needs is thus a central concern of private wealth managers. To take the client objectives into account, investments are frequently adapted to the client’s risk aversion, tax situation, and investment horizon. More...
17/12/08
Commodities
To analyse the significant variations in oil prices over the past year, EDHEC have produced a new position paper entitled "Oil Prices: the True Role of Speculation," which argues that, despite the appeal of blaming speculators, supply-and-demand imbalances, the fall in the dollar and low spare capacity in the oil-producing countries are the major causes of this sharp rise. More...
26/11/08
Alternative Investments
Noël Amenc, David Schröder In July of 2007, we published a major position paper on the subject of hedge
fund replication, entitled "The Myths and
Limits of Passive Hedge Fund Replication: An Attractive Concept… Still a Work-in-Progress." That paper examined from both a theoretical and an empirical standpoint the respective benefits and limits of the two different approaches to hedge fund replication, "factor-based replication" and
"payoff distribution replication." The present publication covers the industry reactions to last year’s position paper. The objective of the current paper is to compare the results of the analysis of hedge fund replication by EDHEC’s researchers with industry perceptions of the products and techniques that are currently available. More...
26/11/08
Fair Value Accounting
In the context of the measures being taken to put an end to the current financial crisis, the extent to which fair value accounting can be blamed—or whether it can be blamed at all—for the intensification of the slump has been widely debated.
This new EDHEC position paper shows that this debate, which ignores the real issues, has led to accounting changes that are at odds with their objectives. We examine the relevance of the accusations levelled at fair value and of the responses proposed in an attempt to improve the use of fair value accounting and make it more relevant to the economic realities faced by banks as well as
by companies in general. More...
25/11/08
Commodities
In US dollar terms, crude oil prices increased 525% from the end of 2001 through July 31st, 2008. Was this rally yet another speculative bubble? Specifically, was the oil-price rally based on speculative excess rather than fundamental supply-and-demand factors? In a new position paper, “The Oil Markets: Let the Data Speak for Itself”, we argue that when the oil supply-and-demand balance becomes sufficiently tight and that when effective OPEC spare capacity becomes sufficiently low that it is logical to see very high prices to ration demand and/or encourage additional supply. That is the job and message of price, even if this message is unpopular. More...
07/11/08
Regulation
If all institutional investors are bound by regulations that force them to sell risky assets during downturns, these assets will ultimately be absorbed by unregulated long-term investors. Additional examination shows that, in the current environment, sovereign wealth funds and governments are the possible buyers of these assets. As public intervention entails moral hazard, it follows that for the stability of the financial system throughout the business cycle regulations must be improved. More...
28/10/08
Alternative Investments
David E. Kuenzi, Remy Chaudhuri, Zhihui Dong Hedge funds are often referred to as absolute return strategies, yet investors are aware that most hedge funds do in fact take on a variety of systematic and quasi-systematic exposures. If a manager of a fund of hedge funds (FoF) finds that the exposure of the FoF to a certain systematic exposure or the risk level broadly has become excessive, then the FoF manager may want to hedge. The purpose of this article is to outline the major issues involved with overlay hedging in a fund of funds portfolio and to provide relevant solutions to these issues. These include the determination of whether to hedge, exposure estimation, hedging single exposures with futures, options, and other instruments, and hedging exposures broadly using a multi-factor approach. More...
24/10/08
Alternative Investments
In this paper we extend Hasanhodzic and Lo (2007) by assessing the out-of-sample performance of various non-linear and conditional hedge fund replication models. We find that going beyond the linear case does not necessarily enhance the replication power. On the other hand, we find that
selecting factors on the basis of an economic analysis can lead to a substantial improvement in out-of-sample replication quality, whatever the underlying form of the factor model. More...
23/09/08
Indices
This paper analyses a set of characteristics-based indices that have recently been launched on the US market and have been said to outperform standard market cap-weighted indices over particular backtest samples.
The EDHEC authors, Noël Amenc, Felix Goltz and Véronique Le Sourd, analyse the performance of an exhaustive list of such indices and show that the outperformance over value-weighted indices may be negative over long time periods and that characteristics-based indices do not significantly outperform simple equal-weighted indices.
Furthermore, an analysis of both the style exposures and the sector exposures of characteristics-based indices reveals a significant value tilt. When properly adjusting for this tilt, these indices do not show any abnormal performance. A revisited version of this paper was published in the February 2009 issue of European Financial Management. More...
03/09/08
Asset Management
The EDHEC European ETF Survey 2008 is part of the EDHEC Risk and Asset
Management Research Centre’s Indices and Benchmarking research programme. This programme has led to extensive research on indices and benchmarks in both the hedge fund universe and the more traditional investment classes. In 2006, EDHEC published a study of the quality
of major stock market indices. Following up on this study, EDHEC is carrying out
work that assesses the advantages and disadvantages of various new forms of
equity indices.
In view of the growth and development of ETFs in Europe, and in view of their
growing popularity as investment media for both index management and
the construction of benchmarks, it is only natural that EDHEC should devote
significant resources to research into ETFs. In 2006, with the support of iShares, we published the first EDHEC European ETF survey. The present survey, an update and extension of the 2006 survey, sheds light on recent developments and trends in ETF investing. More...
23/07/08
Governance
Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer This paper is part of a broader project examining the rules of political disclosure and their consequences. It presents new measures of disclosure by MPs in 126 countries, and examines their determinants as well as consequences for corruption. The measures distinguished between disclosure by law and in practice, between public and non-public disclosure, as well as between more and less comprehensive disclosure. These distinctions motivated the creation of several indices of disclosure in sample countries. More...
01/07/08
Asset Management
As part of its ongoing policy of monitoring asset management practices and comparing them with the results of academic research, the EDHEC Risk and Asset Management Research Centre undertook an in-depth survey of the risk management, portfolio construction, strategic allocation, and performance measurement practices of European asset managers and investors.
The EDHEC European Investment Practices Survey is built on a sample of 229 institutional investors and asset managers who, with respect both to the nationality of survey respondents and to the amount of assets under management, are largely representative of the European asset management industry. In all, respondents to the survey have more than €10 trillion of assets under management and include the major European firms in the industry (nearly fifty respondents manage more than €100 billion each). More...
25/06/08
Indexes
Noël Amenc, Felix Goltz, Véronique Le Sourd This paper analyses a set of characteristics-based indices that were recently launched on the US market and that, it has been argued, outperform standard market cap-weighted indices over particular backtest samples by a considerable margin. It analyses the performance of an exhaustive list of these indices and shows that i) the outperformance over value-weighted indices may be negative over long time periods, and ii) that there is no significant outperformance over simple equal-weighted indices. Furthermore, an analysis of both the style and sector exposures of characteristics-based indices reveals a significant value tilt. When properly adjusting for this tilt, these indices do not show any abnormal
performance. Therefore, the paper argues that the main value these indices add may be to provide investors with a liquid, systematic, and relatively cheap alternative to other value-tilted strategies. However, if one recognises the possibility to implement tilts of exposures to sector or style factors, constructing
factor portfolios that beat the characteristics-based indices in the sense of mean-variance efficiency is straightforward. More...
23/06/08
Commodities
Ana-Maria Fuertes, Joëlle Miffre, Georgios Rallis This paper examines the combined role of momentum and term structure signals for the design of profitable trading strategies in commodity futures markets. With significant annualized alphas of 10.14% and 12.66% respectively, the momentum and term structure strategies appear profitable when implemented individually. More...
10/06/08
Commodities
James Chong, Joëlle Miffre The article studies the temporal variations in the conditional return correlations between commodity futures and traditional asset classes (global stock and fixed-income indices). It reveals that the conditional correlations between commodity futures and S&P500 returns fell over time, a sign that commodity futures have become better tools for strategic asset allocation. The correlations with equity returns also fell in periods of above average volatility in equity markets. We see this as welcome news to long institutional investors as they need the benefits of diversification most in periods of high volatility in equity markets. Similarly, falls in return correlations between commodity futures and Treasury-bills go hand in hand with rises in short-term interest volatility, suggesting that adding commodity futures to Treasury-bill portfolios reduces risk further in volatile interest rate environments. More...
20/05/08
Performance
René Garcia, Georges Tsafack Equity returns are more dependent in bear markets than in bull markets. Previous studies have argued that a multivariate GARCH model or a regime switching (RS) model based on normal innovations could reproduce this asymmetric extreme dependence. This paper shows analytically that it cannot be the case. It proposes an alternative model that allows for tail dependence in lower returns and keeps tail independence for upper returns. This model is applied to international equity and bond markets to investigate their dependence structure. More...
20/05/08
Alternative Investments
Antonio Diez de los Rios, René Garcia Several studies have put forward that hedge fund returns exhibit a non-linear relationship with equity market returns, captured either through constructed portfolios of traded options or piece-wise linear regressions. This paper provides a statistical methodology to unveil such non-linear features with the returns on any selected benchmark index. It estimate a portfolio of options that best approximates the returns of a given hedge fund, accounts for this search in the statistical testing of the contingent claim features, and tests whether the identifed non-linear features have a positive value. More...
07/05/08
Alternative Investments
Joseph Eagleeye, Hilary Till This article focuses on risk management within the context of a total-return futures program centered on commodities. The following issues are addressed: the evaluation of normal versus eventful risk, the sizing of trades and strategy buckets, and the construction of a portfolio, which takes into consideration these risk and sizing metrics. The article provides examples from three historical portfolios in order to make this discussion concrete and practical. More...
06/05/08
Corporate Governance
Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer This paper presents a new measure of legal protection of minority shareholders against expropriation by corporate insiders: the anti-self-dealing index. Assembled with the help of Lex Mundi law firms, the index is calculated for 72 countries based on legal rules prevailing in 2003, and focuses on private enforcement mechanisms, such as disclosure, approval, and litigation, governing a specific self-dealing transaction. This theoretically-grounded index predicts a variety of stock market outcomes, and generally works better than the previously introduced index of anti-director rights. A revisited version of this paper was published in the June 2008 issue of the Journal of Financial Economics. More...
22/04/08
Finance and Economics
Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer In the last decade, economists have produced a considerable body of research suggesting that the historical origin of a country's laws is highly correlated with a broad range of its legal rules and regulations, as well as with economic outcomes. This paper summarizes this evidence and attempts a unified interpretation. It also addresses several objections to the empirical claim that legal origins matter. Finally, it assesses the implications of this research for economic reform. A revisited version of this paper was published in the June 2008 issue of the Journal of Economic Literature. More...
22/04/08
Indexes
While an ever increasing share of equity
assets is invested in indexing strategies, the
standard practice of using capitalisation
weighting to construct stock market indices
has been the object of much criticism.
In response to this criticism, equity indices
with different weighting schemes have
emerged. Some indices use "fundamental"
metrics (Arnott, Hsu, and Moore 2005) to
weight the component stocks. In recent
years, the market for such characteristics-based
indices has grown tremendously, with
more and more providers launching and offering
them. Institutional investors have allocated
significant amounts to these alternatives
to value-weighted indices. Likewise, a wide
range of exchange-traded funds on these
new indices is now available. More...
18/04/08
Corporate Governance
Aron Balas, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer Djankov et al. (2003a) propose and measure for 109 countries in the year 2000 an index of formalism of legal procedure for two simple disputes: eviction of a non-paying tenant and collection of a bounced check. For a sub-sample of 40 countries, that authors compute this index every year starting in 1950, which allows them to study the evolution of legal rules. They find that between 1950 and 2000 the formalism of legal procedure did not converge, and possibly diverged, between common law and French civil law countries. At least in this specific area of law, the results are inconsistent with the hypothesis that national legal systems are converging, and support the view that legal origins exert long-lasting influence on legal rules. More...
09/04/08
Alternative Investments
Devraj Basu, Roel Oomen, Alexander Stremme Investing in commodities has been gathering momentum, particularly with hedge and even pension funds having being attracted to this asset class. Much of the attraction appears to be the fact that a diversified portfolio of commodities seems to produce equity like returns with low or negative
correlation with equities. More...
09/04/08
Alternative Investments
David E. Kuenzi During the last few years, there has been growing interest in the use of factor models for performing risk and exposure analysis of hedge funds. While interpreting directional and spread related factors in this context is fairly straightforward, interpreting non-linear options exposures often is not. Given the variety of activities that can produce options exposures, the interpretation of multi-factor output in this regard can be more of an art than a science. This paper explores the variety of hedge fund manager activities that can drive options exposures in multi-factor analysis More...
16/03/08
Institutional Investment
In its response to the CEIOPS consultation on the preliminary technical specifications for the fourth quantitative impact survey (QIS4), EDHEC argues that the main risk faced by life insurance companies is not taken into account in the standard formula. This risk is that following market (or other significant) losses, a wave of surrenders leaves shareholders bearing the entirety of losses. This is the phenomenon that led to such bankruptcies as that of Executive Life, where losses made public by rating agencies and the media triggered a wave of surrenders and bankruptcy–even though the losses alone were thought bearable for some time. More...
14/02/08
Alternative Investments
In a context of moderate performance in the stock and bond markets in 2007, Funds of Hedge Funds, which are often taken to give an aggregate view of the industry’s performance, returned 10.07% on average for the year, compared to 3.53% for the S&P 500 and 4.14% for the Lehman Global US Treasury Bond index.
In “Hedge Fund Performance in 2007”, Véronique Le Sourd, Senior Research Engineer with the EDHEC Risk and Asset Management Research Centre provides a strategy-by-strategy account of the performance of each hedge fund strategy included in the EDHEC Alternative Indexes. While all hedge fund strategies posted positive returns, a majority saw a slight fall-off in performance compared to 2006. Only five of the thirteen strategies obtained higher returns than in 2006: CTA Global, Emerging Markets, Equity Market Neutral, Global Macro, and Short Selling.
More...
14/02/08
Alternative Investments
Following recent initiatives by major investment banks such as Merrill Lynch and Goldman Sachs, EDHEC researchers have undertaken a detailed critical analysis of the various methodologies involved in hedge fund replication offers, examining the benefits and limits of the “factor-based” and “pay-off” distribution approaches. In the study, “The Myths and Limits of Passive Hedge Fund Replication,” co-written by Lionel Martellini with Noël Amenc, Walter Géhin and Jean-Christophe Meyfredi, the authors find that overall, one could only possibly hope to achieve truly satisfying results by combining the best of the two competing approaches. A revisited version of this paper was published in the Fall 2008 issue of the Journal of Alternative Investments. More...
22/01/08
Tactical Allocation
Devraj Basu, Roel Oomen and Alexander Stremme. This paper focuses on the use of market variables that exploit the linkages between spot, futures and derivatives markets, as opposed to the business cycle indicators employed in most of the earlier studies. Spot and futures market linkages are exploited by using commercial and non-reportable hedging pressure as the predictive variables while the linkages between the derivatives and spot markets are exploited using the VIX index, a proxy for implied volatility. More...
22/01/08
Real Estate
The EDHEC Risk and Asset Management Research Centre has released a new survey that is drawn from its research programme in asset allocation and alternative diversification. This programme has led to extensive research on the benefits, risks, and integration methods of alternative classes and instruments in asset allocation.
Real estate, probably the most traditional of alternative classes, is enjoying renewed favour as institutional investors search for diversification benefits and competitive yields. Institutional demand for real estate exposure has brought about improvements in market transparency and the development of new indirect and synthetic investment tools. With target allocations to real estate
increasing, research into real estate as an asset class must enable industry participants to refine traditional approaches and to consider real estate within the bounds of asset management and asset-liability management. It is in this way that research can help real estate take its place in multistyle, multi-class portfolios, contribute to the design of integration methods that optimise its risk/return trade-off, and, finally, enable the class to deliver on its full potential.
The EDHEC European Real Estate Investment and Risk Management Survey, the first phase of this research, takes stock of developments in the real estate investment market, reviews academic evidence on allocation to and management of real estate, and analyses the results of a large-scale, pan-European survey of institutional practices. More...
14/12/07
Alternative Investments
Lionel Martellini, Volker Ziemann. In the presence of non-normally distributed asset returns, optimal portfolio selection techniques require not only estimates of variance-covariance parameters, but also estimates of higher-order moments and comoments of the return distribution. This paper extends existing literature, which has mostly focused on the covariance matrix, by introducing improved estimators for the coskewness and cokurtosis parameters. In an empirical analysis, the authors find that the use of these enhanced estimates leads to significantly better out-of-sample performance. More...
16/11/07
Performance
Noël Amenc, Véronique Le Sourd. Fund ratings are a widely used tool for fund promoters and fund subscribers. They serve to evaluate fund performance on a risk and return basis in an easily understandable way, and allow the performance of different funds to be compared. In this context, the quality and the robustness of the ratings is a critical subject for both investment management firms and investors. Though the predictive capability of fund ratings has not been proved, numerous studies performed on US mutual funds have concluded that fund subscribers are widely influenced by fund ratings in making their choice. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Performance Measurement. More...
15/10/07
Alternative Investments
This paper introduces a suitable extension of the Black-Litterman Bayesian approach to portfolio construction in the presence of non-trivial preferences about higher moments of asset return distributions. It also presents an application to active style allocation decisions in the hedge fund universe. Overall the results suggest that significant value can be added in a hedge fund portfolio through the systematic implementation of active style allocation decisions provided that a sound investment process is implemented that accounts for both non-normality and parameter uncertainty in hedge fund return distributions. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Portfolio Management. More...
01/10/07
Risk Management
This paper introduces a multivariate copula approach to Value-at-Risk estimation for fixed income portfolios. Using a parsimonious model to extract time-varying parameters used as proxies for factors affecting the shape of the yield curve, and a Student copula to model the dependence structure of these factors, we are able to generate VaR estimates that strongly dominate standard VaR estimates in formal out-of-sample tests. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Fixed Income. More...
01/10/07
Alternative Investments
Noël Amenc, Felix Goltz Hedge fund indices have been criticised for a lack of representativity and for their biases, to the point that serious doubts about the usefulness of hedge fund indices have been raised by investors and regulators. This paper examines whether the problems that are outlined for hedge fund indices also exist for other indices that seem to be widely accepted. The drawbacks of hedge fund indices pointed out in the literature do indeed exist. However, in this paper, the authors point out that there are possible solutions to these problems. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
18/09/07
Indices
A recent publication by the EDHEC Risk and Asset Management Research Centre has drawn conclusions that highlight the shortcomings of well known capitalisation- or price-weighted stock market indices and argues that the choice of benchmark for asset allocation or performance measurement is a task requiring particular care.
In a call for reactions to this publication, EDHEC finds that the answers of the more than eighty respondents (asset management firms, pension funds, insurance companies, private banks, etc.) tend to reinforce the conclusions drawn by the original publication.
Although it would at first appear that the majority of respondents are not, in general, dissatisfied with the indices they use as benchmarks (18.82% of respondents express degrees of dissatisfaction), further examination soon reveals that the shortcomings of these indices, such as inefficiency, lack of stability, and susceptibility to price bubbles, are widely recognised by the
industry professionals responding to EDHEC’s call for reactions. The call for reactions also shows that a considerable majority of respondents plan
to review the indices they use as benchmarks, either immediately or in the future. More...
17/09/07
Alternative Investments
European leaders, eager for an explanation absolving them of responsibility, have once again laid blame on the seemingly detrimental role played by hedge funds in this summer’s crisis. This crisis is the result of a sudden fall in asset
prices, combined with increased aversion to risk on the part of investors. To suggest that hedge funds are to blame for this crisis is simplistic but tempting, as their speculative, unregulated, and opaque nature make them easy targets - all the while, more delicate market and regulatory issues are avoided. So, as a counterpoint to these accusations that often come from France, it seemed necessary to us to provide a French perspective on the lessons to be learned with respect to financial regulation in France. More...
17/09/07
Alternative Investments
Hilary Till. On September 18th, 2006, market participants were made aware of a large hedge fund’s distress. On that date, Nick Maounis, the founder of Amaranth Advisors, LLC, had issued a letter to his investors, informing them that the fund had lost an estimated 50% of their assets month-to-date. By the end of September 2006, these losses amounted to $6.6-billion, making Amaranth’s collapse the largest hedge-fund debacle to have thus far occurred. There were (and are) many surprising aspects of this debacle. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
06/09/07
Performance Measurement
Xiafei Li, Chris Brooks, Joëlle Miffre The article analyses the impact of trading costs on the profitability of momentum strategies in the UK and concludes that losers are more expensive to trade than winners. The observed asymmetry in the costs of trading winners and losers crucially relates to the high cost of selling loser stocks with small size and low trading volume. Since transaction costs severely impact net momentum profits, the paper defines a new low-cost relative-strength strategy by shortlisting from all winner and loser stocks those with the lowest total transaction costs. More...
22/08/07
Alternative Investments
Hilary Till. This brief article suggests three approaches for how to benefit from structural opportunities in the commodity markets, drawing from the recently published book, “Intelligent Commodity Investing.” The author notes how over long time horizons, the term structure of a commodity futures curve becomes the dominant driver of return for individual futures contracts. For shorter time horizon opportunities, the author discusses mean-reverting commodity spread trades that have approximately seasonal frequencies. More...
02/08/07
Alternative Investments
Within the equity risk sub-module of the third Quantitative Impact Study (QIS3) undertaken by the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS), a preamble to the Solvency II supervisory standard, all alternative investments are subject to a capital charge of 45%, nearly 50% higher than the 32% applied to regular equity exposures. In this article, we briefly go over the calculations required for equity risk, and then include a reminder of why hedge funds on average are certainly not the riskiest bet an investor can make. More...
23/07/07
Alternative Investments
Rian Akey, Hilary Till, Aleks Kins. This article comprehensively covers the new field of natural-resources fund-of-funds investing. The authors first explain why the demand for such an investment has emerged, and then discuss the opportunities that an actively-managed natural-resources fund-of-funds can potentially exploit. More...
23/05/07
Order Execution
Rudy De Winne, Catherine D’Hondt This paper investigates why traders hide their orders and how other traders respond to hidden depth. Using a logit model, the authors provide empirical findings suggesting that traders use hidden orders to manage both exposure risk and picking off risk. Using probit models, they show that hidden depth increases order aggressiveness. The authors' interpretation of this empirical evidence is threefold. First, hidden depth detection is possible and frequent. Second, when traders detect hidden volume at the best opposite quote, they strategically adjust their order submission to seize the opportunity for depth improvement. A revisited version of this paper was published in the September 2007 issue of Review of Finance (formerly European Finance Review). More...
09/05/07
Performance Measurement
Xiafei Li, Chris Brooks, Joëlle Miffre Numerous studies have documented the failure of the static and conditional capital asset pricing models to explain the differences in returns between value and growth stocks. This paper examines the post-1963 value premium by employing a model that captures the time-varying total risk of the value-minus-growth portfolios. The results show that the conditional variance model incorporating time-varying idiosyncratic risk can fully capture the post-1963 value premium. The conclusion is robust to the criterion used to sort stocks into value and growth portfolios, to the inclusion of the size premium into the conditional asset pricing model, and to the country under review (US and UK). This paper therefore adds to the debate on the possible role of idiosyncratic risk in explaining equity returns. More...
04/05/07
Alternative Investments
David Kuenzi Volatility is an alternative beta—a risk premium captured by hedge fund managers and investment bank proprietary traders—that is today moving closer to the mainstream and should be thought of as a veritable asset class. For many investors, it is difficult to derive intuition as to why volatility should deserve an ongoing allocation within a larger portfolio. If volatility is an asset class, then to what accepted asset class can it be compared? More...
27/04/07
Asset Pricing
Dominic O'Kane The author describes an approximation methodology for constructing independent loss distributions based on adjusting the binomial distribution. This method can handle both homogeneous and heterogeneous loss portfolios. He finds that this simple algorithm provides an excellent fit to the exact distribution for a broad range of correlations and portfolio credit quality. More...
26/04/07
Best Execution
In response to the CESR's public consultation on best execution under MiFID, EDHEC strongly defend the idea that the analysis of the total net proceeds of financial transactions represent the most important factor for assessing execution quality. But this analysis also represents the most significant conceptual and technical challenge the industry will face in order to consistently monitor execution quality, and therefore allow best execution to become a tangible and measurable objective for investment firms. More...
17/04/07
Alternative Investments
Joëlle Miffre, Georgios Rallis The article looks at the performance of 56 momentum and contrarian strategies in commodity futures markets. The authors build on the research of Erb and Harvey (2006) who focus on one momentum strategy. While contrarian strategies do not work, 13 momentum strategies are found to be profitable in commodity futures markets over horizons that range from 1 to 12 months. A revisited version of this paper was published in the June 2007 issue of the Journal of Banking and Finance. More...
04/04/07
Alternative Investments
Harry M. Kat, Joëlle Miffre This paper highlights the importance of non-normality risks and tactical asset allocation in assessing hedge fund performance. As such, it underlines the inaccuracies of previous papers on hedge fund performance that ignored higher moments in the distribution of hedge fund returns and assumed constant asset allocation. Correcting for these shortcomings, the authors find that failure to account for non-normality risks and tactical asset allocation on average leads to an overstatement of performance by 1.54% and to incorrect statistical inference on the performance of 1 out of 4 funds. On average, non-normality risks and conditional asset allocation explain 23.1% of the abnormal performance of hedge funds as commonly perceived. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
04/04/07
Best Execution
In this study, EDHEC, while recognising that the directive allows the conditions in which investment companies can operate on the regulated markets or over-the-counter to be harmonised, warns of the eventual adverse effects relating to the obligation of transparency for systematic "internalisers" and the obligation of "best execution". The authors find, in the case of the obligation imposed on systematic “internalisers” to maintain a public spread of prices, that it is prejudicial for this restriction to be removed for the least liquid securities. This provision will lead, in a certain number of cases, (small-caps on markets that are centrally organised at present), to a deterioration in the pre-trade transparency that is currently provided to investors. More...
02/04/07
Alternative Investments
Hilary Till In a previous paper, Life at Sharpe's End, the author touched upon the difficulty of using standard measures to evaluate a number of hedge fund strategies. In this article, after reviewing these difficulties, she discusses the state-of-the-art methodology in this area. More...
30/03/07
Alternative Investments
Hilary Till For futures programs, the meaning of rate-of-return numbers can be somewhat ambiguous, given that one does not need to set aside capital in the amount of a program’s funding level. Instead, an investor can fractionally fund an account using “notional funding.” More...
30/03/07
Alternative Investments
James Chong, Joëlle Miffre In this paper, the authors study the conditional risk premia of commodity futures and the way their returns vary over time with those of traditional asset classes (S&P500 stocks and US T-bonds). They draw the following two conclusions. First, that historically investors earned significant risk premia on 19 of the 21 commodity futures markets studied. Second, that the conditional correlations between equity and commodity futures returns fell over time. More...
30/03/07
Performance Measurement
Xiafei Li, Joëlle Miffre and Chris Brooks This article considers whether the widely documented momentum profits are a compensation for time-varying unsystematic risk as described by the family of autoregressive conditionally heteroscedastic models. The motivation for estimating a GJR-GARCH(1,1)-M model stems from the fact that, since losers have a higher probability than winners to disclose bad news, one cannot assume a symmetric response of volatility to good and bad news. A revisited version of this paper was published in the April 2008 issue of the Journal of Banking & Finance. More...
30/03/07
Performance
This paper presents the state of the art of performance measurement in the area of traditional investment, from a simple evaluation of portfolio return to the more sophisticated techniques including risk in its various acceptations. It also describes models that take a step away from modern portfolio theory and allow a consideration of cases beyond mean-variance theory. More...
30/03/07
Wealth Management
Working from the observation that the contribution of asset-liability management techniques developed for institutional investors is not yet familiar within private banking, a new study from the EDHEC Risk and Asset Management Research Centre, entitled “Asset-Liability Management Decisions in Private Banking” shows the expected benefits of a transposition of that kind. According to the authors of the study, Noël Amenc, Lionel Martellini and Volker Ziemann, asset-liability management represents a genuine means of adding value to private banking that has not been sufficiently explored to date. Within the framework of private financial management offerings, personal wealth managers tend to confine their clients to mandates that are only differentiated through their level of volatility, without the client’s personal wealth constraints and objectives being genuinely taken into account in order to determine the overall strategic asset allocation. In that sense, private wealth management is not sufficiently different from the management of a diversified or profiled mutual fund. More...
19/03/07
Alternative Investments
In a report entitled “Hedge Fund Performance: A Vintage Year for Hedge Funds?”, Véronique Le Sourd, Senior Research Engineer with the EDHEC Risk and Asset Management Research Centre provides a comprehensive account of the performance of each hedge fund strategy included in the EDHEC Alternative Indexes. The author reveals that funds of hedge funds, which are often taken to give an aggregate view of the industry’s performance, yielded a solid return of 11.25% in 2006. More...
19/03/07
Performance Measurement
Ana-Maria Fuertes, Joëlle Miffre and Wooi-Hou Tan This paper examines the role of non-normality risks in explaining the momentum puzzle of equity returns. It shows that momentum returns are not normally distributed. About 70 basis points of the annual momentum profits can be attributed to systematic skewness risk. This finding is pervasive across nine strategies and is reinforced when time dependencies in abnormal returns and risks are explicitly modeled. The analysis also reveals that the market and skewness risks of momentum portfolios evolve over the business cycle in a manner that is consistent with market timing and risk aversion. More...
05/02/07
Institutional Investment
A new EDHEC position paper entitled "CP20: Significant improvements in the Solvency II framework but grave incoherencies remain", by Philippe Foulquier, Director of the EDHEC Financial Analysis and Accounting Research Centre, and Samuel Sender, Research Associate with the EDHEC Risk and Asset Management Research Centre, contains EDHEC's answer to CP20, a consultation process initiated by CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) on the "Advice to the European Commission in the Framework of the Solvency II Project on Pillar I Issues". More...
26/01/07
Performance Measurement
Daniel Giamouridis and Ioanna Ntoula This paper compares a number of different approaches for determining the Value at Risk (VaR) and Expected Shortfall (ES) of hedge fund investment strategies. The authors compute VaR and ES through completely model-free
methods, as well as through mean/variance and distribution model-based methods. Among the models considered certain specifications can technically address autocorrelation, asymmetry, fat tails, and time-varying variances which are typical characteristics of hedge fund returns. They find that conditional mean/variance models coupled with appropriate distributional assumptions improve their ability to predict VaR, 1% VaR in particular. They also find that the goodness of ES prediction models is primarily influenced by the distribution
model rather than the mean/variance specification. More...
25/01/07
Alternative Investments
In a working paper entitled ‘Quantification of Hedge Fund Default Risk’, which led to the publication of a full article in the Fall issue of the Journal of Alternative Investments, Jean-René Giraud and Stéphane Daul of the EDHEC Risk and Asset Management Research Centre, together with co-author Corentin Christory, examined numerous cases of hedge fund default in order to find the common factors behind fund failures.
The objective of the paper was to provide an initial framework for quantifying the non-financial extreme risk of hedge funds with the aim of factoring it into the portfolio construction phase. The paper examines the statistical properties of hedge fund failures and attempts to identify essential risk factors that can tentatively explain why certain funds are more likely to default on their investors and creditors than others. A revisited version of this paper was published in the Fall 2006 issue of the Journal of Alternative Investments. More...
24/01/07
Alternative Investments
In a reply to the CESR Issues Paper on the eligibility of hedge fund indices for the purpose of UCITS, the EDHEC Risk and Asset Management Research Centre argues that hedge fund indices should not be required to offer more controls and more transparency than existing financial indices such as stock market indices. Likewise, their construction should not be subjected to detailed rules for choosing constituents and implementing rebalancing and weighting mechanisms. More...
23/01/07
Exchange-Traded Funds
In a new survey, The EDHEC European ETF Survey 2006, the EDHEC Risk and Asset Management Research Centre has carried out an in-depth study on the use of ETFs (Exchange-Traded Funds) by European investors. The results of the survey show that following rapid growth, ETFs are being widely used by European institutional investors, private bankers and asset managers. The increasing popularity of ETFs is reflected in the responses of survey participants. More than half of the respondents are current or planned users of ETFs in equity investments (61%), and this is the case for more than a quarter of respondents (26%) for bond investments.
More remarkably, among those that use Equity ETFs, 92% were satisfied, which indicates an extremely high level of satisfaction. With 45% of responses, the most distinct reason for satisfaction was the reliability of the tracking error. 23% were satisfied with the good performance of ETFs, while 21% were pleased with the level of liquidity, and only 4% cited the reduced expenses of ETFs. Interestingly, half of the respondents who were not satisfied with Equity ETFs pointed to the poor level of liquidity of ETFs. More...
18/01/07
Transaction Cost Analysis
A new report from EDHEC Risk Advisory, Transaction Cost Analysis in Europe: Current and Best Practices, which was commissioned by HSBC Investment Bank, reviews the conditions in which buy-side firms (traditional and alternative) are currently monitoring transaction costs and investigates the various issues related to transaction cost analysis in the context of the Markets in Financial Instruments Directive due to be enforced in November 2007. This directive contains an important provision related to Best Execution. More...
16/01/07
Institutional Investment
A new study jointly produced by the EDHEC Risk and Asset Management Research Centre and the EDHEC Financial Analysis and Accounting Research Centre entitled ‘The Impact of IFRS and Solvency II on Asset-Liability Management and Asset Management in Insurance Companies’ reveals the contradictions inherent in the current Solvency II and IFRS provisions for insurance companies. The report shows notably that the numerous provisions proposed by the IFRS are at odds with the good risk management practices put forward by Solvency II. While IFRS and Solvency II should lead to a genuine evolution in the management of insurance companies, by empowering them with respect to their risks (identification, measurement and management), one is forced to observe today that the standards implemented often oppose their initial objectives: the adoption of modern asset management and ALM techniques with a view to reducing the exposure to risks is considerably penalised by the IFRS treatment by leading to additional purely accounting volatility, without any connection to the economic reality.
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11/12/06
Performance Measurement
Walter Géhin This paper, which is being written to provide an overview of the multitude of publications we have seen on hedge fund performance, is the result of a reading and analysis of about 200 studies on this subject. The issue of performance measurement in the hedge fund industry has led to literature that is both abundant and controversial. The explanation of this complexity lies in the particular features of alternative funds. More...
17/11/06
Institutional Investment
In a new position paper by Philippe Foulquier, director of the EDHEC Financial Analysis and Accounting Research Centre, and Samuel Sender, research associate with the EDHEC Risk and Asset Management Research Centre, entitled ‘QIS 2: Modelling that is at odds with the prudential objectives of Solvency II’, EDHEC regrets the approach chosen by the CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) for the European Commission as proposed in the QIS 2 (Quantitative Impact Study 2), which does not favour optimal management of the risks of European insurance companies. In light of the changing face of risks and how they are perceived, the existing prudential rules are totally inadequate and the European Commission has established a vast project to overhaul the methods used for calculating the solvency of insurance companies. More...
15/11/06
Asset Allocation
Recent finance research that draws on behavioral psychology suggests that investors systematically make errors in forming expectations about asset returns. These errors are likely to cause significant mis-pricing in the short run, and the subsequent reversion of prices to their fundamental level implies that measures of investor sentiment are likely to be correlated with stock returns. A number of empirical studies using both market and survey data as proxies for investor sentiment have found support for this hypothesis. This paper investigates whether investor sentiment (as measured by certain components of the University of Michigan survey) can help improve dynamic asset allocation over and above the improvement achieved based on commonly used business cycle indicators. More...
31/10/06
Indices
At a presentation to the members of the Af2i (French association of institutional investors) in Paris on September 12th, Noël Amenc, Director of the EDHEC Risk and Asset Management Research Centre, warned his institutional audience about the dangers of relying solely on stock market indices as a benchmark for their investment management performance. More...
18/10/06
Alternative Investments
In a little over a week, Amaranth Advisors, a respected, diversified multi-strategy hedge fund, lost 65% of its $9.2 billion assets. In a paper entitled ‘EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle’, noted commodities expert Hilary Till, Research Associate with the EDHEC Risk and Asset Management Research Centre and Principal of Premia Capital Management, LLC, examines how Amaranth could have suffered such massive losses and draws lessons from this debacle for investors, funds of fund & energy fund risk managers, multi-strategy hedge fund managers, policy makers, and the alternative investment industry as a whole. More...
02/10/06
Commodity Futures
Hilary Till By now it has become well-known that commodities have had superior performance over the past four and a half years; commodity investing has become a sign of sophistication. Because commodity index investing has grown from an obscure, niche strategy to a more widely accepted investment, there has been a need to better understand the drivers of historical commodity returns and risks. An investor would presumably then be in a better position to make informed judgments on the future prospects of a commodity investment. More...
25/09/06
Alternative Investments
Hilary Till. This article, which was originally written as a two-part series, discusses the innovative ways in which academics and practitioners are enhancing asset allocation methodologies in order to incorporate hedge funds.
It begins by discussing the current practice in asset allocation work and goes on to describe the unique problems that occur when this methodology is applied to hedge funds. It also discusses a number of leading edge solutions to these problems. Included are anecdotes from anonymous hedge fund managers and traders, which illustrate some of the academic points made in the article. A revisited version of this paper was published in the GARP Risk Review, the Journal of the Global Association of Risk Professionals, September/October and November/December 2002 issues. More...
04/08/06
Commodities
Hilary Till and Joseph Eagleeye. This article covers investment in commodities through futures contracts. It notes the unique sources of risk and return for such investments and also discusses the factors that one should take into consideration before deciding upon how much of a portfolio should be in commodities. We will see how an investment in commodities can be used as either a diversifier for a traditional portfolio or as a source of returns, depending on the market environment. Finally, it is argued that some of the considerations that apply to equity investing are also relevant for commodity investing. More...
04/08/06
Alternative Investments
Hilary Till. Academic criticism of classic Capital Asset Pricing Model (CAPM) performance measures is not new. Until recently it was fine to use the Sharpe ratio as a way of summarizing the attractiveness of an investment. Only now have the shortcomings of using traditional performance measures to evaluate all manner of strategies become relevant to investors. This article touches on the problems with using traditional performance evaluation methods and summarize the state-of-the-art in alternative performance evaluation techniques. A revisited version of this paper was published in Quantitative Finance, (2002) 2:4 pp.237-238. More...
02/08/06
Alternative Investments
Hilary Till and Joseph Eagleeye. Given the ongoing stock market downdraft since March 2000, U.S. mutual fund inflows have dramatically slowed down while hedge fund investing has exploded. Some have argued that there is an accelerating convergence between the hedge fund industry and traditional institutional fund management. This article will argue the opposite: that in a very fundamental way, these two investment industries are still quite distinct. A revisited version of this paper was published in Quantitative Finance, (2003) 3:3 pp. C42-C48.
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02/08/06
Alternative Investments
Hilary Till. A distinguishing feature in evaluating the risk of hedge fund strategies is the relative paucity of data, as noted by Feldman et al (2002). This creates great discomfort in attempting to apply statistical techniques to sparse datasets.
This article will discuss five further approaches that academics and practitioners have proposed since this summer for addressing the risk considerations that are unique to hedge funds. A revisited version of this paper was published in Quantitative Finance, (2002) 2:6 pp. 409-411.
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02/08/06
Commodities
Hilary Till. While it is useful to review the past performance of commodities, investors are most concerned about what to expect going forward. And unfortunately, one cannot look in the rear-view mirror to see what is coming up ahead. In this article, the author reviews the drivers of commodity returns along with some observations on what the future may hold. More...
27/07/06
Alternative Investments
Noël Amenc and Mathieu Vaissié. Despite institutional investors’ growing interest in funds of hedge funds, little attention has been paid so far to their added value and/or the sources of their added value. This is all the more striking in that funds of funds are far from transparent and are, with their double-fee structure, relatively costly investment vehicles. The objective in this paper is to fill that gap and find out whether funds of funds add value through strategic allocation and active management. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Investing. More...
27/07/06
Alternative Investments
An article in the June 2006 edition of the European Central Bank’s Financial Stability Review (FSR) claims that hedge fund activities pose considerable risk to the financial system. We disagree with this conclusion, which is based on mere speculation. We outline the fallacies in the reasoning of the FSR article and makes some propositions on how to assess the welfare impacts of hedge funds. In particular, we argue that it would be worthwhile for financial regulators to work towards obtaining data on hedge fund leverage and counterparty credit risk. Such data would allow a reliable assessment of the question of systemic risk. In addition, we argue that besides evaluating potential systemic risk, it should be recognised that hedge funds play an important role as “providers of liquidity and diversification.” More...
27/07/06
Asset Allocation
Felix Goltz, Lionel Martellini, Volker Ziemann. In this paper, the authors examine 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. A revisited version of this paper was published in the June 2006 issue of the Journal of Fixed Income.
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21/06/06
Indexes & Benchmarking
The construction of an appropriate benchmark is one of the major challenges of the performance measurement process. Without quality benchmarks, it is not possible to differentiate between returns due to the investment style of the manager and returns due to the talent of the manager, which in turn makes it difficult to measure relative returns. This paper examines the issue of hedge fund strategy benchmarks in the light of improvements in hedge fund index construction methodologies and management principles, and with the launch of new series of investable hedge fund indices. The paper notably tries to answer the following question: Can investors in the alternative arena measure the relative returns of hedge funds? A revisited version of this paper was published in the May-June 2005 issue of the Journal of Indexes. More...
01/06/06
Alternative Investments
David E. Kuenzi, Xu Shi. The use of asset-based style analysis (ABS) in the context of hedge fund investments continues to take hold within the industry. Many of the factors used in performing this analysis are straightforward and well-accepted—particularly in the area of equity hedge funds, where a long market index factor, a small-minus-large factor, and a value-minus growth factor seem to be well-accepted components of an equity hedge fund ABS model. Little attention, however, has been given to understanding the most relevant volatility factors and the relative merits of various instruments in this context. More...
19/05/06
Alternative Investments
Hilary Till, Jodie Gunzberg. In this article, the authors introduce readers to commodity (natural resource) futures programs. They begin the article by describing the present investment landscape as one where return compression in a number of popular hedge fund strategies has led absolute-return investors to investigate other promising return sources. This includes the highly volatile natural-resource markets, which Lammey (2004) describes as a "paradise for speculators." More...
04/04/06
Risk
Hilary Till. This paper provides a risk framework for fiduciaries considering using a core-satellite approach to investing. While the article mainly covers the additional risk measurement techniques, which are needed when investing in hedge funds, its recommendations are also relevant for other investments that have default, devaluation, and/or liquidity risks associated with them. While the article’s focus is on quantitative techniques, the author notes that a fiduciary must also understand the economic basis for each investment’s returns. More...
31/03/06
Risk
Hilary Till. Commodity futures investing has only recently entered the mainstream. As recently as 2001, there was only $10 billion invested in commodity indexes whereas during the fall of 2005 this figure had increased to over $70 billion, according to Rodger (2005). Once an institution has obtained its core commodity exposure through a commodity index investment, the next logical step is to include active commodity managers for further value-added. More...
30/03/06
Commodities
Hilary Till, Joseph Eagleeye. The recent outperformance of commodities versus equities has caused a positive re-evaluation of commodities by both retail and institutional investors. While the commodity markets provide a manager with ample opportunities for creating portfolios of diverse strategies, there are a number of challenges in doing so. In this article, the authors provide two examples of those challenges: (1) the correlations amongst commodities vary seasonally due to meaningful weather events, and (2) the entrée of China as a dominant force in the commodity markets has created new correlation footprints. The main implication of these observations is that risk management in the commodity markets is a very dynamic process. More...
30/03/06
Alternative Investments
Hilary Till. Hedge funds do not easily fit into the current way institutions go about investing. In this article, the author reviews both academic and practitioner research from the standpoint of a hypothetical institutional investor who is looking into whether hedge funds make sense for their portfolio. A revisited version of this paper was published in the Spring 2004 issue of The Journal of Alternative Investments. More...
30/03/06
Commodities
Hilary Till, Joseph Eagleeye. In this article, the authors note how a set of active commodity strategies could potentially add value to an investor’s commodity allocation. But they also emphasize the due care that must be taken in risk management and implementation discipline, given the “violence of the fluctuations which normally affect the prices of many … commodities,” as Keynes (1934) put it. A revisited version of this paper was published in the Fall 2005 issue of The Journal of Wealth Management. More...
30/03/06
Asset Allocation
Jakša Cvitanic, Ali Lazrak, Lionel Martellini, Fernando Zapatero. In this paper, the authors derive a closed-form solution for the optimal portfolio of a non-myopic utility maximizer who has incomplete information about the “alphas”, or abnormal returns of risky securities. They show that the hedging component induced by learning about the expected return can be a substantial part of our demand. A revisited version of this paper was published in the Winter 2006 issue of the Review of Financial Studies. More...
23/03/06
Alternative Investments
Hilary Till, Jodie Gunzberg. In this article, the authors provide the busy reader with a survey of articles that were written over the past four years on hedge funds. Specifically, they review the economic basis for hedge fund returns and then discuss some of the logical consequences of these observations. Next, they summarize the general statistical properties of hedge fund strategies. They then examine what the appropriate performance measurement and risk management techniques are for these investments. And lastly, they briefly cover ways that investors can consider incorporating hedge funds within their overall portfolios. A revisited version of this paper was published in the Winter 2005 issue of the Journal of Wealth Management. More...
21/03/06
Commodities
Barry Feldman, Hilary Till. In this paper, the authors examine the role of backwardation in the performance of passive long positions in soybeans, corn and wheat futures over the period of 1950 to 2004. They find that over this period, backwardation has been highly predictive of the return of a passive long futures position when measured over long investment horizons. The share of return variance explained by backwardation rises from 24% at a one-year horizon to 64% using five-year time periods. More...
16/03/06
Asset-Liability Management
Lionel Martellini. In this paper, the author considers an intertemporal portfolio problem in the presence of liability constraints. Using the value of the liability portfolio as a natural numeraire, he finds that the solution to this problem involves a three fund separation theorem that provides formal justification to some recent so-called liability-driven investment solutions offered by several investment banks and asset management firms, which are based on investment in two underlying building blocks (in addition to the risk-free asset), the standard optimal growth portfolio and a liability hedging portfolio. More...
09/03/06
Alternative Investments
The results of the EDHEC European Alternative Diversification Practices Survey, which enabled EDHEC to produce a detailed assessment of current institutional practices in Europe, were presented to a distinguished group of institutional investors at the EDHEC Institutional Investor Summit in London on February 14th. The study generated responses from 151 European institutional investors representing, at 30/09/2005, a total volume of over one trillion euros of assets under management. The survey shows that 51% of European institutional investors are already exposed to hedge fund strategies. These represent, on average, 7% of their global assets. More...
20/02/06
Alternative Investments
Daniel Capocci Hedge funds have an absolute return performance objective stated independently of the global market conditions. Nevertheless they have been compared to classical bond and equity indices by academics since the late 90s. Independently of their absolute or relative performance it is of particular importance to determine if some hedge funds consistently outperform their peers. This is exactly the objective of this study: Do some hedge funds consistently and significantly outperform others? Do some individual funds or some strategies continuously create alpha in comparison to others? More...
03/02/06
Alternative Investments
Following its meeting in Sonoma, California on July 10-11, 2005, the Financial Economists Roundtable (FER), an international group of senior financial economists, issued a statement in which it warned about the risks involved in investing in hedge funds. The EDHEC Risk and Asset Management Research Centre, which has carried out a multi-faceted research programme on hedge funds over the past three years, has published a paper by Noël Amenc, PhD, and Mathieu Vaissié in response to the FER statement in which it comments on the FER’s recommendations. More...
18/01/06
Alternative Investments
Walter Géhin The goal of modelling is to find one or more factors that offer the best explanatory power for a given variable. Applied to hedge fund returns, it allows their sources to be better understood. In the search for significant factors, two approaches can be employed, namely return-based style factors (RBS factors) and asset-based-style factors (ABS factors). More...
10/01/06
Alternative Investments
Lionel Martellini, Mathieu Vaissié and Volker Ziemann. One of the by-products of the bull market of the 90’s has been the consolidation of hedge funds as an important segment of financial markets. It was recently announced that the value of the hedge fund industry worldwide had passed the $1 trillion mark for the first time, with approximately 7,000 hedge funds in the world, around 1,000 of which were launched in 2003. One of the key reasons behind the success of hedge funds in institutional money management is that such alternative investment strategies seem to provide diversification benefits with respect to other existing investment possibilities. In an attempt to fully capitalize on such beta benefits in a top-down approach, investors or (funds of hedge funds) managers must be able to rely on robust techniques for optimization of portfolios including hedge funds. More...
19/12/05
Operational Risk
Jean-René Giraud Operational risk is by far the most complex and intriguing issue investors are dealing with when allocating capital to hedge funds. Due to sophisticated trading strategies, potentially high levels of portfolio turnover, investment in illiquid or difficult to price instruments and a moderately regulated environment, hedge funds tend to exhibit high levels of extreme risks related to non-financial events (fraud and misappropriation, misrepresentation, model risk, infrastructure risk, etc.). More...
06/12/05
Asset-Liability Management
Noël Amenc, Lionel Martellini, Felix Goltz. As a consequence of entering a more mature stage, the hedge fund industry has extended its investor base to institutional investors, who are now faced with a large number of product offerings including not only single hedge funds, but also funds of funds and, more recently, investable indexes. Although the existing literature seems to concur on the interest of hedge funds as valuable investment alternatives, there still remain a large a large number of institutional investors who wonder whether they should invest in hedge funds, and more importantly, how they should do it. In order to address these questions, this paper looks at the risk factors in hedge fund strategies and attempts to assess the diversification benefits investors can expect from allocating part of their wealth to hedge funds.
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18/11/05
Asset-Liability Management
Lionel Martellini, Volker Ziemann. Institutional investors in general and pension funds in particular have been dramatically affected by negative stock market returns at the beginning of the millennium. In the context of a cumulative asset/liability deficit that was estimated at more than £55 billion in 2003 for the companies in the FTSE 100,
institutional investors are seeking new asset classes or forms of investment management that would allow them to broaden their traditional choice of asset allocation. An alternative investment offering has been introduced in the past several years, allowing investors to optimise the risk/return combination of their portfolio. A revisited version of this study was published in the June 2006 issue of The IFCAI Journal of Financial Risk Management. More...
05/10/05
Alternative Investments
Daniel Capocci. Using an original database of 634 market neutral hedge funds, this study formally analyses the market neutrality of market neutral funds which are particular in the hedge fund universe since the only objective of these funds is to provide positive returns completely independent of the market conditions. We start by analysing this neutrality using various market neutral indices before focusing on individual fund returns. Finally, an analysis based on ex-post beta helps us explaining and confirming our previous results. We perform this analysis over the global January 1993- December 2002 period as well as on bull and bear market periods. More...
16/08/05
Alternative Investments
In a major survey of 183 industry players, including institutional investors and hedge fund and fund of hedge fund managers, conducted from May 31st to July 8th 2005, the EDHEC Risk and Asset Management Research Centre has found that alternative investment professionals are upbeat about future prospects for the industry and do not see the so-called “capacity effect” as a major threat to future profitability.
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10/08/05
Risk Management
Jean-Christophe Meyfredi. When risk managers make decisions, they need them to be based upon reliable measures. Strong assumptions are often made to simplify the risk estimation process and there has to be a trade-off between ease of estimate and accuracy. In this paper, “Is there a gain to explicitly modelling extremes? A risk measurement analysis”, Jean-Christophe Meyfredi of the Edhec Risk and Asset Management Research Centre develops a copula-based approach in order to estimate the Value-at-Risk of portfolios containing financial assets. He proposes a survival copula, the Heavy Right Tail copula, which could solve many difficulties that risk managers currently have to face. More...
15/07/05
Structured Products
Lionel Martellini, Koray Simsek and Felix Goltz. Institutional investors in general and pension funds in particular have been dramatically affected by recent market downturns. This seems to be surprising given that an increasingly thorough range of structured products has been developed over the past few years, which allows investors to tailor the risk-return profile of their portfolio in a more efficient way than simple linear exposure to traditional asset classes. The salient characteristic of structured products is the repackaging of strategies that involve long and short positions in derivatives and the underlying or a risk-free asset into an investment vehicle that is easily accessible by investors. More...
07/07/05
Asset Allocation
In this paper, we generalize Markowitz analysis to the situations involving an uncertain exit time. Our approach preserves the form of the original problem in that an investor minimizes portfolio variance for a given level of the expected return. However, inputs are now given by the generalized expressions for mean and variance-covariance matrix involving moments of the random exit time in addition to the conditional moments of asset returns. While efficient frontiers in the generalized and the standard Markowitz case may coincide under certain conditions, we demonstrate, by means of an example, that in general that is not true. In particular, portfolios efficient in the standard Markowitz sense can be inefficient in the generalized sense and vice versa. As a result, an investor facing an uncertain time-horizon and investing as if her time of exit is certain would in general make sub-optimal portfolio allocation decisions. Numerical simulations show that a significant efficiency loss can be induced by an improper use of standard mean-variance analysis when time-horizon is uncertain. A revisited version of this paper was published in the June 2006 issue of Management Science.
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01/07/05
Alternative Investments
Walter Géhin, Mathieu Vaissié. Two studies, by Watson Wyatt and UBS (both from March 2005), give a pessimistic view of the hedge fund industry’s capacity to generate long-term returns, due to its increasing size. Unfortunately, these studies focus almost exclusively on alpha. In the present paper, we show the importance of considering not only the exposure to the market (the traditional beta), but also the other exposures (the alternative betas) to cover all the sources of hedge fund returns. To do so, we examine the real extent to which the variability and level of hedge fund returns are affected by (static) betas, dynamic betas (i.e. factor timing), and pure alpha (i.e. security selection). A revisited version of this study was published in the Summer 2006 issue of The Journal of Alternative Investments.
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13/06/05
Fixed-Income Strategies
This paper presents evidence of predictability in the time-varying shape of the U.S. term structure of interest rates using a robust recursive modelling approach based on a Bayesian mixture of multi-factor models. We find that variables such as default spread, equity volatility, short-term and forward rates, among others, can be used to predict changes in the slope of the yield curve, and also, albeit to a lesser extent, changes in the curvature of the yield curve. By using systematic trading strategies based on butterfly swaps, we also find that this evidence of predictability in the shape of the yield curve is economically significant in addition to being statistically significant. A revisited version of this paper was published in the June 2005 issue of the Journal of Fixed Income. More...
01/06/05
Derivatives
N. Amenc, L. Martellini, P. Malaise. In this paper, "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", the authors emphasize the need for the hedge fund industry to adopt a consumer (investor)-driven approach, as opposed to the current producer (manager) perspective, and call 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, they present evidence on the use of derivatives by managers for generating and delivering abnormal performance, and also for packaging such performance in a form that is consistent with the modern core-satellite approach to institutional portfolio management, for which they explore both a standard static version and also a dynamic extension allowing for dissymmetric control of active management risk. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Portfolio Management. More...
23/05/05
Alternative Investments
F.-S. Lhabitant. The delegation of asset management services is a source of potential agency problems between investors and their portfolio managers. Most of these problems can be avoided by using an adequate compensation theme. While the academic literature tends to be somewhat inconclusive as to whether or not, and to what degree optimal compensation should be linked to relative or absolute performance, industry practice seems to show a clear pattern: mutual funds charge an asset-based fee, while hedge funds charge both an asset-based fee and a performance fee. In this article, the author discusses the advantages and drawbacks of both types of fees. A revisited version of this paper was published in The Journal of Financial Transformation. More...
29/04/05
Asset-Liability Management
J. M. Mulvey, B. Pauling, K. D. Simsek. This paper presents a multi-period stochastic network model for integrating corporate financial and pension planning. Pension planning in the United States has gained importance with the population aging and the growth of retirement accounts. In certain cases, the pension plan assets are several times larger than the value of the company itself (e.g. General Motors – Market cap: $19 billion, Pension plan assets: $67 billion, Estimated pension fund deficit: $25 billion – in December 31, 2002; see General Motors Corporation (2003)). More...
09/03/05
Alternative Investments
In 2004, Edhec launched an international consultation process on the implementation of a new framework for Funds of Hedge Funds reporting. This consultation process was based on a series of recommendations proposed by Edhec with regard to the academic state-of-the-art on risk measurement in the alternative universe. The results of this consultation were presented to a panel of journalists on February 17th in London at a meeting hosted by FIMAT. A revisited version of this study was published in The Journal of Risk Finance, 1st Quarter 2006. More...
08/03/05
Alternative Investments
J. M. Mulvey, S. S. N. Kaul, K. D. Simsek. The Mt. Lucas index provides a systematic approach for capturing a portion of the return of trend-following commodity traders. The authors analyze the Mt. Lucas Index across different historical periods, evaluating its performance within a multi-period asset allocation framework. Their results indicate that the index improves the overall return/risk characteristics of the multi-period asset
allocation model. They show that the total return consists of: 1) T-Bill returns on marginable assets, 2) static returns from trendfollowing futures markets, and 3) rebalancing gains. The importance of the third element is emphasized. More...
02/02/05
Alternative Investments
D. Darius, A. Ilhan, J. M. Mulvey, K. D. Simsek, R. Sircar. Selected hedge funds employ trend-following strategies in an attempt to achieve superior risk adjusted returns. The authors employ a lookback straddle approach for evaluating the return characteristics of a trend following strategy. The strategies can improve investor performance in the context of a multi-period dynamic portfolio model. The gains are achieved by taking advantage of the funds’ high level of volatility. More...
02/02/05
Asset-Liability Management
J. M. Mulvey, K. D. Simsek. Leading pension plans employ asset and liability management systems for optimizing their strategic decisions. The multi-stage models link asset allocation decisions with payments to beneficiaries, changes to plan policies and related issues, in order to maximize the plan’s surplus within a given risk tolerance. Temporal aspects complicate the problem but give rise to special
opportunities for dynamic investment strategies.Within these models, the portfolio must be re-revised in the face of transaction and market impact costs. The re-balancing problem is posed as a generalized network with side conditions. We develop a specialized algorithm for solving the resulting problem. A real-world pension example illustrates the concepts. More...
02/02/05
Performance
The Edhec Risk and Asset Management Research Centre recently released a research paper that is highly critical of the existing fund rating systems.
Originating in 2002, when EuroPerformance, the leading French firm for the dissemination of mutual fund data, approached the Edhec Risk and Asset Management Research centre to consider the implementation of a value-added offering in the area of external analysis of the performance and risks of European investment funds, the Rating the Ratings document constitutes a detailed summary of the critical study and puts into perspective the responses given to the inadequacies of the existing ratings by the EuroPerformance-Edhec Style Ratings.
The method followed to implement the design of these new ratings was to carry out a thorough study of the insufficiencies of the existing rating methods in order to correct them by relying on the state-of-the-art in portfolio risk and performance measurement in a business context.
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01/12/04
Indexes
L. Martellini, M. Vaissié, F. Goltz. Following a growing concern among investors about the quality of hedge fund index return data, and given the lack of capacity and transparency specific to that industry, this paper questions from an academic perspective whether it is feasible or not to design hedge fund benchmarks satisfying all defining properties for a good index. In particular, in an attempt to test whether achieving investability necessarily comes at the cost of representatitivity, as sometimes claimed by hedge fund index providers, we borrow from the asset pricing literature the concept of factor replicating portfolios and apply it to the benchmarking of hedge fund style returns. A revisited version of this paper was published in the March 2007 issue of European Financial Management. More...
09/11/04
Asset Pricing
C. Blanchet-Scalliet, N. El Karoui, L. Martellini. This paper addresses the problem of pricing and hedging a random cash-flow received at a random date in a general stochastic environment. We first argue that specific timing risk is induced by the presence of an uncertain time-horizon if and only if the random time under consideration is not a stopping time of the filtration generated by prices of traded assets. In that context, we provide an explicit characterization of the set of equivalent martingale measures, as well as a necessary and sufficient condition for a convenient separation between adjustment for market risk and timing risk. A revisited version of this paper was published in the October 2005 issue of the Journal of Economic Dynamics and Control. More...
08/11/04
Asset Allocation
N. Amenc, J.-R. Giraud, P. Malaise, L. Martellini. Newly launched fixed-income Exchange Traded Funds (ETFs) have specifically been designed to track bond market indices, and share many of the same benefits of equity ETFs, including in particular lower costs, transparency, buying and selling flexibility, all day tracking and trading. While it has often been argued that ETFs were natural investment vehicles for implementing passive indexing strategies, we show in this paper that the benefits of ETFs are actually much larger than traditionally reported, as these instruments can also be used to implement almost the full range of existing investment strategies. More...
04/11/04
Hedge Fund Indices
M. Vaissié, W. Géhin. In the mutual fund industry, which is based on a passive investment approach, and where respecting the tracking error is an inevitable notion, the use of indices is necessary in order to play on exposure to the market. In the hedge fund universe, where it is frequently said that performance is extracted from managers, reflecting active asset management, the implementation of hedge fund indices may be surprising, because the notion of index is commonly associated with the notion of passive management. However, picking the best performers in the hedge fund universe appears to be a very challenging task. More...
02/11/04
Asset Allocation
N. Amenc, P. Malaise, L. Martellini, D. Sfeir. It has long been argued that equity managers can use derivatives markets to help implement a systematic risk management process designed to enhance the performance of their portfolio (see for example Ineichen (2002) for a recent reference). These derivatives instruments can be used in the context of completeness portfolios that are designed not to interfere with the original portfolio composition, so that they can be used to generate what have been labeled portable beta benefits (Amenc et al. (2004)). Consider for example the case of long/short equity hedge fund managers. A revisited version of this paper was published in the Winter 2004 issue of Economic & Financial Computing. More...
22/10/04
Risk
Jean-Christophe Meyfredi. What is risk? The answer is far from simple. The definition depends on the context and is highly subjective. A first attempt is to define risk as the possibility of something unexpected occurring. But what could the constituents of those expected and
unexpected events be? Again there is no single answer. The field of finance is a symptomatic example where risk is multiform. It is usual to distinguish between market risk, credit risk, liquidity, operational and legal risks. More...
18/10/04
Alternative Investments
W. Géhin. The issue of performance measurement in the hedge fund industry has led to literature that is both abundant and controversial. The explanation for this complexity lies in the particular features of alternative funds. Hedge funds invest in a heterogeneous range of financial assets and cover a wide range of strategies that have different risk and return profiles. Even though the current studies on hedge fund performance appear to be confusing, due to conflicting conclusions and criticism of the methods employed in previous papers, they contribute to an improvement in the knowledge of alternative funds, and leading approaches are confirmed. More...
13/10/04
Alternative Investments
M. Vaissié. Over the last few years, alternative investment strategies have dramatically gained in popularity. Initially reserved for High Net Worth Individuals (HNWI), they progressively drew the attention of individual and institutional investors, to reach approximately 1 trillion dollars in assets under management today. However, while HNWI were looking for absolute returns, private and institutional investors are more focused on capital preservation and/or risk-adjusted performance. More...
07/10/04
Business Analysis
N. Amenc, J.R. Giraud, L. Martellini, M. Vaissié. Over the last few years institutional investors’ traditional portfolios have failed to meet their objectives in terms of risk and performance. Investors have thus shown growing interest in new forms of diversification, especially in investment vehicles that offer better protection during extreme market conditions. A revisited version of this paper was published in the Winter 2004 issue of the Journal of Alternative Investments. More...
22/09/04
Asset Allocation
N. Amenc, P. Malaise, L. Martellini. Tracking error is not necessarily bad. Just like with good and bad cholesterol, there is “good” tracking error, which refers to out-performance of a portfolio with respect to the benchmark, and “bad” tracking error, which refers to underperformance with respect to the benchmark. By severely restricting the amounts invested in active strategies as a result of tight tracking error constraints, investors forgo an opportunity for significant out-performance, especially during market downturns. In this paper, the authors introduce a new methodology that allows investors to gain full access to good tracking error, while maintaining the level of bad tracking error below a given threshold. A revisited version of this paper was published in the Fall 2004 issue of The Journal of Portfolio Management. More...
22/09/04
Asset Allocation
N. Amenc, P. Malaise, L. Martellini, J.R. Giraud. Recent market difficulties have drawn attention to the risk management practices of institutional investors. Particularly significant was the fact that negative equity market returns were eroding plan assets at the same time as declining interest rates were increasing benefit obligations. These events have spotlighted the weakness of current funding standards for corporate defined benefit pension plans. They have also emphasized the weakness of investment practices. More...
03/09/04
Indexes
Francois-Serge Lhabitant. Over the past decade, the hedge fund industry has grown – big time. According to estimates, the number of hedge funds increased from 2,000 to 8,000, assets under management went from US $67 billion to US $800 billion, and inflows of money to hedge funds have never been greater. This growth was essentially driven by the attractive risk-adjusted performance achieved by hedge funds, their ability to protect capital in negative equity markets, and the shrinkage in proprietary trading activities, which coincided neatly with a welter of hedge fund launches. More...
27/04/04
Hedge Funds
François-Serge Lhabitant. There is an increasing amount of evidence that shows the benefits of considering hedge funds as an asset class at the strategic asset allocation level. The investors’ greatest challenge remains the identification of desirable investment vehicles, since very little formal quantitative analysis of hedge funds has been done in the past. In this paper, we suggest an innovative approach to hedge fund investing, which is valid at the individual fund level as well as at the aggregate portfolio level (e.g. portfolio of hedge funds). This approach only relies on hedge funds historical returns. We provide several illustrations, including static and dynamic style analysis, benchmark construction, performance assessment, and value at risk calculations. A revisited version of this paper was published in the Journal of Financial Transformation, nº 1. More...
27/04/04
Hedge Funds
François-Serge Lhabitant, Michelle Learned De Piante Vicin. Hedge funds are often thought of as being high-risk investments and many investors in the past have shied away from them for fear of making large losses. However, over the recent years, hedge funds have generally substantially outperformed equities, with much lower volatility. As a consequence, they are now in strong demand, particularly when one remembers that any risk associated with hedge fund investing diminishes in importance when the funds are repackaged into fund of funds products. A revisited version of this paper was published in the April 2004 issue of the Journal of Financial Transformation. More...
27/04/04
Asset Allocation
N. Amenc, P. Malaise, L. Martellini, D. Sfeir. In this paper, we show 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. A revisited version of this paper was published in the Summer 2004 issue of The Journal of Portfolio Management. More...
08/01/04
Indexes
N. Amenc, L. Martellini, M. Vaissié. As a response to the needs of investors, the Edhec Risk and Asset Management Research Centre proposes an
original solution by constructing an “index of indexes”, the performance of which is posted on a dedicated web site
(www.edhec-risk.com). The aim of the methodology used to construct this “index of indexes” is to construct a
benchmark with degrees of representativity and stability that are significantly higher than those of the indexes
available on the market. This methodology was first introduced in Amenc, Martellini (2002a). More...
08/01/04
Indexes
M. Vaissié. The aim of this document is to provide a detailed presentation of the different hedge fund indices in order to
highlight their strengths and weaknesses. To analyse the reasons for the heterogeneity of their performances, we
will focus on the following five points: Transparency & Independence, Accuracy of the data and punctuality, Stability, Representativity, Purity.
The first three points will allow us to provide details on the index construction methods. The following two points will allow us to understand the consequences of the
heterogeneity of the construction methods in terms of representativity and purity. We will thus be able to reply to
the following question: are all hedge funds created equal?
More...
29/12/03
Risk
J-C. Meyfredi. In this paper we aim to show how risk managers can benefit from this integration of EVT (Extreme Value Theory) into their VaR calculation and how they could easily reduce the effects of some of the important drawbacks that VaR presents.
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18/12/03
Risk
O. Jokung, J.C. Meyfredi. The present paper conducts an empirical study by examining the Market Model and the three
versions of the 4-State Model (translated, rotated and un-rotated) in a mean-beta framework.
Using daily returns from the CAC 40 Index's assets, we find that the explanatory power of the 4-
State Model is greater than the one of the Market Model and this effect is improved by rotation.
A reduction in the non-systematic risk is also observed when switching from Market Model to 4-
State Models. Surprisingly, the betas are more stable when using any version of the 4-State
Model. This could have a strong impact on portfolio diversification and call widely held opinion
into question. More...
18/12/03
Alternative Investments
On 11th December 2003 in Paris, Edhec presented the results of its survey on alternative multimanagement in Europe, the Edhec European Alternative Multimanagement Practices survey.
This study, sponsored by FIMAT, is based both on a review of all the professional and academic research on alternative investment and a survey of the practices of European multimanagers, to which 61 firms (investors, advisors and funds of funds) replied, representing a total of 136 billion euros under management. The key findings of this study were published in the March 2004 issue of The Journal of Financial Transformation.
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17/12/03
Alternative Investments
Noël AMENC, François HAAS, Mathieu VAISSIÉ. Over the past few years the alternative investment industry has developed spectacularly, attracting so much investor interest that it appears at times to have taken on the proportions of a “fad”. This article sets out to chart the development of this phenomenon. We will start out by attempting to define the broad outlines and trends of this rapidly evolving industry. We will then try to show why this style of management requires specific risk
analysis techniques and performance indicators. This will enable us to assess the impact of alternative investment management on financial market dynamics, and identify the conditions under which these management strategies might “usefully” contribute to the functioning of financial markets and become a lasting feature in the world of asset management. More...
05/12/03
Performance
A. Ranaldo and L. Favre. In the last decade, the hedge fund industry grew impressively. Many studies show that hedge funds have a superior performance and that the introduction of hedge funds in a classical portfolio enhances the portfolio's performance. The attractive performance of hedge funds may be due to inadequate measurement techniques of the risk-return profile of hedge funds. The main aim of this paper is to investigate how to price hedge funds and, in particular, the validity of the traditional asset pricing models in measuring the risk-return trade-off in hedge fund investment.
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04/11/03
Performance
G. Hübner. This paper presents a generalization of the Treynor ratio in a multi-index setup. The solution proposed in this paper is the simplest measure that keeps Treynor's original interpretation of the ratio of abnormal excess return (Jensen's alpha) to systematic risk exposure (the beta) and preserves the same key geometric and analytical properties as the original single index measure. More...
17/10/03
Performance
D. Capocci and G. Hübner. Using one of the largest hedge fund databases ever used (2796 individual funds including 801 dissolved), this paper investigates hedge funds performance using various asset pricing models, and a new factor that takes into account the fact that some hedge funds invest in emerging bond markets. More...
17/10/03
Tactical Allocation
N. Amenc, P. Malaise, L. Martellini and D. Sfeir. There is now a consensus in empirical finance that expected asset returns, and also variances and covariances, are, to some extent, predictable. The use of predetermined variables to predict asset returns has produced new insights into asset pricing models, and the literature on optimal portfolio selection has recognized that these insights can be exploited to improve on existing policies based upon unconditional estimates. While the performance of tactical style allocation models is well documented in equity markets, very little evidence is available on the performance of systematic dynamic allocation decisions among various bond indices. This paper investigates the predictability of fixed-income style portfolio returns using a robust recursive modeling approach based on multi-factor models for the return on bond indices.
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17/10/03
Performance
D. E. Kuenzi. When investment managers construct strategy benchmarks and manage their portfolios against them, they are making an implicit bet that some subset of the broader investment universe will produce better risk and return characteristics than a similar published index over the long term. Despite the long-term focus of this decision, it is nonetheless active in nature. Strategy benchmark performance should thus be evaluated as a source of manager value-added. More...
17/10/03
Derivatives
M. Schyns, Y. Crama and G. Hübner. Many mathematical models used in management science do not impose any complex
restrictions on the parameter values arising in a given problem. As a consequence, when the instances arise from a specific
real-world application, the models under consideration are usually sufficiently robust
to remain meaningful even if their numerical parameters are not estimated
with very high accuracy or, alternatively, if small perturbations are applied to
the parameter values. Things can be quite different, however, with models developed for financial
applications. Indeed, in such applications, many models turn out to be utterly
meaningless unless one can ensure that the data sets are realistic and internally
consistent with the assumptions underlying the model.
More...
17/10/03
Performance
L. Martellini, B. Urosevic. Executive compensation packages are often valued in an inconsistent manner: while employee
stock options (ESOs) are typically valued ex-ante, i.e., before uncertainties are resolved, cash
bonuses are valued ex-post, i.e., by discounting the realized cash grants. Such a lack of
consistency can, potentially, distort empirical results. A related, yet mostly overlooked, problem
is that when ex-post valuation is used pay-performance measures can not be well defined.
Consistent use of ex-ante valuation for all components of a compensation package would
simultaneously resolve both of these problems and provide a natural framework for the analysis of agency problems. More...
01/09/03
Tactical Allocation
Noël Amenc, Philippe Malaise, Lionel Martellini and Daphne Sfeir. Even though there is little evidence of predictability in stock specific risk in the absence of private information, most equity market neutral managers still rely on stock picking as the preferred way to generate abnormal returns. In this paper, we document the benefits of a new form of market-neutral portfolio strategy that aims at deliver absolute return over the full business cycle through systematic equity style timing decisions. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Alternative Investments. More...
15/07/03
Business Analysis
Edhec has conducted a major survey into the practices of the leading 400 European asset management firms which generated responses from 60 companies. The survey is the first study conducted in Europe dealing with the application of the results of academic research within investment management companies. The survey results reveal that in spite of their extensive knowledge of the concepts involved in research into portfolio management and the progress made, the major European asset managers were either not implementing them or not adopting them rapidly as part of their investment management process. More...
12/06/03
Performance
Noël Amenc, Daphne Sfeir, Lionel Martellini.
In this paper, we propose an integrated framework for assessing the risk-adjusted performance of
mutual fund managers. The methodology is designed so as to be consistent not only with modern
portfolio theory but also with constraints imposed by practical implementation in a context where
the presence of a variety of investment styles needs to be accounted for. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Performance Measurement.
More...
28/02/03
Indexes
Different hedge fund indexes available on the market are constructed from different data, according to diverse selection criteria and methods of construction, and they evolve at differing paces. As a result of this heterogeneity, investors cannot rely on competing hedge fund indexes to obtain a “true and fair” view of hedge fund performance. Investors are therefore at a loss when selecting benchmarks. As a response to the needs of investors, the Edhec Risk and Asset Management Research Center proposes an original solution by constructing an “index of indexes.” The aim of the methodology used to construct this “index of indexes” is to construct a benchmark with degrees of representativity and stability that are significantly higher than those of the indexes available on the market. More...
27/02/03
Performance
Noël Amenc, Susan Curtis, Lionel Martellini.
That hedge funds start gaining wide acceptance while they still remain a somewhat mysterious asset class enhances the need for a better measurement their performance.
This paper is an attempt to test the ability of hedge fund managers to generate superior performance. More...
18/02/03
Asset Allocation
Jaksa Cvitanic, Ali Lazrak, Lionel Martellini and Fernando Zapatero.
What percentage of their portfolio should investors allocate to hedge funds? The
only available answers to the above question are set in a static mean-variance framework,
with no explicit accounting for uncertainty on the active manager’s ability to generate abnormal return, and usually generate unreasonably high allocations to hedge funds.
In this paper, we apply the model introduced in Cvitanic, Lazrak, Martellini and Zapatero
(2002) for optimal investment strategies in the presence of uncertain abnormal returns
to a database of hedge funds. Wefind that the presence of model risk significantly
decreases an investor’s optimal allocation to hedge funds. Another finding of this
paper is that low beta hedge funds may serve as natural substitutes for a significant
portion of an investor risk-free asset holdings. A revisited version of this paper was published in the February 2003 issue of Quantitative Finance. More...
23/01/03
Risk
Octave Jokung, Jean-Christophe Meyfredi
The present paper conducts an empirical study by examining the Market Model and the three versions of the 4-State Model (translated, rotated and un-rotated) in a mean-beta framework. Using daily returns from the CAC 40 Index’s assets, we find that the explanatory power of the 4-State Model is greater than the one of the Market Model and this effect is improved by rotation. A reduction in the non-systematic risk is also observed when switching from Market Model to 4-State Models. Surprisingly, the betas are more stable when using any version of the 4-State Model. More...
25/11/02
Asset Allocation
Noël Amenc, Lionel Martellini.
Two competing approaches are used in practice to build portfolios: bottom-up and topdown.
The bottom-up approach is the older and the more traditional, and focuses on
individual stock picking. The top-down approach gives more importance to the choice of
different markets as opposed to individual security selection, and, as such emphasizes the
importance of asset allocation. More...
20/11/02
Tactical Allocation
Lionel Martellini, Daphné Sfeir.
Tactical Asset Allocation (TAA) broadly refers to active strategies that seek to
enhance portfolio performance by opportunistically shifting the asset mix in a
portfolio in response to the changing patterns of return and risk. More...
20/11/02
Asset Allocation
Noël Amenc, Lionel Martellini.
This paper attempts to evaluate the out-of-sample performance of an improved estimator
of the covariance structure of hedge fund index returns, focusing on its use for optimal
portfolio selection. A revisited version of this paper was published in the Fall 2002 issue of the Journal of Alternative Investments. More...
13/11/02
Tactical Allocation
Noël Amenc, Sina El Bied, Lionel Martellini.
While there has been a significant amount of research on the predictability of traditional
asset classes, very little is known about the predictability of returns emanating from alternative vehicles such as hedge funds. This paper attempts to fill this gap by documenting evidence of predictability in hedge fund returns. A revisited version of this paper was published in the September/October 2003 issue of the Financial Analysts Journal. More...
13/11/02
Indexes
Noël Amenc, Lionel Martellini.
The fact that hedge funds have started to gain widespread acceptance while remaining a somewhat mysterious asset class enhances the need for better measurement and benchmarking of their performance. One serious problem is that existing hedge fund indices provide a somewhat confusing picture of the investment universe. In this paper, we first present detailed evidence of strong heterogeneity in the information conveyed by competing indices. We also attempt to provide remedies to the problem and suggest various methodologies designed to help build a “pure style index”, or “index of the indices” for a given style. More...
13/11/02
Alternative Investments
Noël Amenc, Lionel Martellini, Mathieu Vaissié.
The growth of alternative investment has been considerable in recent years. For both institutional and private investors, it seems that alternative investment now constitutes a distinct class within their overall asset allocation. A revisited version of this paper was published in the July 2003 issue of the Journal of Asset Management. More...
04/11/02
Asset Allocation
Laurent Favre, José-Antonio Galeano. Based on the normal Value-at-Risk, we develop a new Value-at-Risk method called Modified Value-at-Risk. This Modified Value-at-Risk has the property to adjust the risk, measuring with
the volatility only, with the skewness and the kurtosis of the distribution of returns. The Modified
Value-at-Risk allows to measure first the risk of portfolio with assets non normally distributed
like hedge funds or technology stocks and to compute optimal portfolio by minimizing the
Modified Value-at-Risk at a given confidence level. A revisited version of this paper was published in the Autumn 2002 issue of the Journal of Alternative Investments. More...
17/10/02
Performance
Noël Amenc, Lionel Martellini, Daphné Sfeir.
Fund performance measurement is an important issue both for professionals, for whom it is the
justification of their remuneration, and for researchers, for whom the right evaluation of returns and risks constitutes the very core of modern portfolio theory.
This twofold academic and professional issue underlies extensive research and numerous methods
for evaluating the performance of funds.
Indeed, the diversity of the resulting models and methods has consequences on fund performance rankings and the evaluation of fund performance.
Identifying the best managers actually presupposes taking two areas into account - the risk and the management style. The modelling of those two areas is subject to substantial debate and theoretical and statistical options. More...
10/10/02
Asset Allocation
Laurent Favre, Andreas Signer. In this paper, the use mean-variance approach for the determination of the benefits of allocations
to hedge funds is critically evaluated. The advantages of investing in hedge funds are often
explained and demonstrated with reference to a shift in the efficiency frontier of traditional
portfolios. The added value of hedge funds is almost always indicated in a mean-standard
deviation environment and should in our view be reconsidered. The estimated risk exposure can
be quantified by the introduction of Value-at-risk analysis corrected according to higher moments
of distribution. With this new risk measure, we are able to obtain a corrected value. A revisited version of this paper was published in the Summer 2002 issue of the Journal of Alternative Investments. More...
13/08/02
Risk
Eric Molay.
This study reconsiders the subject of describing the expected return of French stocks through different variables: the beta coefficient drawn from the CAPM, the market capitalisation and book-to-price ratio and the si and hi sensitivities to the SMB and HML return premiums taken from Fama and French's three-factor model. More...
20/03/02
Asset Allocation
Laurent Favre, José-Antonio Galeano. In this article, we analyze the returns distribution of Hedge Funds strategies, the average returns
obtained over the past ten years and their correlation with a traditional portfolio. The aim is to
identify the characteristics of each Hedge Fund investment strategy in order to be able to
construct an optimal Hedge Fund portfolio for a Swiss pension fund. We will show that the
classical linear correlation and the classical linear regression cannot be applied for Hedge Funds.
Moreover, we will show that only three strategies, Convertible Arbitrage, Market Neutral and
CTA, give diversification during market downturns. The techniques used are non-linear
regressions and local correlations. A revisited version of this paper was published in the Spring 2002 issue of the Journal of Alternative Investments. More...
17/03/02
Asset Allocation
Noël Amenc, Lionel Martellini.
Despite repeated evidence that asset allocation accounts for a very large fraction of a portfolio return, the industry has never stopped favouring stock picking as the preferred form of active investment strategy. In this paper, we attempt to rehabilitate the importance of active asset allocation in the investment process. A revisited version of this paper was published in the December 2001 issue of the Journal of Financial Transformation. More...
13/11/01
Performance
François-Serge Lhabitant. Under the efficient market hypothesis, overwriting calls or purchasing
insurance should not improve risk-adjusted portfolio returns. A proper analysis
should show that if options are traded at a fair cost, the risk-reward characteristics
of an option position would fall on the efficient market line. In this paper we
show that, due to several limitations of mean-variance analysis, this is not the
case in practice. We quantify and identify the nature of the resulting biases for
performance evaluation, and explain why alternative measures such as semi
variance do not help in avoiding such biases. A revisited version of this paper was published in the Winter, 7(2) issue of Derivatives Quarterly. More...
01/11/00
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