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Asset Pricing
Fousseni Chabi-Yo, René Garcia, Eric Renault Risk aversion functions extracted from observed stock and option prices can be negative as shown by Aït-Sahalia and Lo (2000) and Jackwerth (2000). We rationalize this puzzle by a lack of conditioning on latent state variables. Once properly conditioned, risk aversion functions and pricing kernels are consistent with economic theory. To differentiate between the various theoretical explanations in terms of heterogeneity of beliefs or preferences, market sentiment, state-dependent utility or regimes in fundamentals, we calibrate several consumption-based asset pricing models to match the empirical pricing kernel and risk aversion functions at different dates and over several years. A revisited version of this working paper was published in the April 2008 issue of the Review of Financial Studies. More...
02/03/10
Alternative Investments
Lionel Martellini, Volker Ziemann In the presence of non-normally distributed asset returns, optimal portfolio selection techniques require estimates for variance-covariance parameters, along with estimates for higher-order moments and comoments of the return distribution. This is a formidable challenge that severely exacerbates the dimensionality problem already present with mean-variance analysis. This paper extends the existing literature, which has mostly focused on the covariance matrix, by introducing improved estimators for the coskewness and cokurtosis parameters. A revisited version of this paper is forthcoming in the Review of Financial Studies. More...
19/02/10
Regulation
François-Serge Lhabitant Following the 2008 financial crisis, private financial institutions such as hedge funds and private equity funds have been faced with multiple calls for their regulation, both for consumer protection and systemic reasons. Various proposals for a new regulation have been made and are currently under discussion. The hedge fund community is also open to reasonable regulations. In this paper, we discuss some of the key aspects of the SEC and the European Union proposals and argue that both of them suffer from severe shortcomings. A revisited version of this paper was published in volume 27 (2009) of the Journal of Financial Transformation. More...
02/02/10
Performance
Felix Goltz, Wan Ni Lai Recent studies find that a position in at-the-money (ATM) straddles consistently yields losses. This is interpreted as evidence for the non-redundancy of options and as a risk premium for volatility risk. This paper analyses this risk premium in more detail by i) assessing the statistical properties of ATM straddle returns, ii) linking these returns to exogenous factors and iii) analysing the role of straddles in a portfolio context. A revisited version of this paper was published in the Fall 2009 issue of the Journal of Derivatives. More...
02/02/10
Risk
Bernhard Scherer Hull (2007) writes: “For an asset manager the greatest risk is operational risk”. In 2008, however, asset management companies came under severe pressure not from operational risk, but from market risk. What had been seen as an annuity stream that was thought to expose firms to little or no earnings risk turned out to be directional stock market exposure combined with high operational leverage. A revisited version of this working paper is forthcoming in the Journal of Applied Corporate Finance. More...
30/11/09
Transaction Cost Analysis
Stephen Satchell, Bernhard Scherer We show that non-linear transaction costs generate external effects between accounts due to trade volume dependent marginal transaction costs. For an asset manager with multiple clients this raises the question of fairness. How do I ensure I treat all clients fairly? In general, two possible solutions exist. A revisited version of this paper was published in the Winter 2010 issue of the Journal of Trading. More...
18/11/09
Asset Allocation
Christophette Blanchet-Scalliet, Nicole El Karoui, Monique Jeanblanc, Lionel Martellini Many investors do not know with certainty when their portfolio will be liquidated. Should their portfolio selection be influenced by the uncertainty of exit time? In order to answer this question, we consider a suitable extension of the familiar optimal investment problem of Merton (1971), where we allow the conditional distribution function of an agent’s time horizon to be stochastic and correlated to returns on risky securities. In contrast to existing literature, which has focused on an independent time horizon, we show that the portfolio decision is affected. A revisited version of this paper was published in the December 2008 issue of the Journal of Mathematical Economics. More...
18/11/09
Private Wealth Management
Noël Amenc, Lionel Martellini, Vincent Milhau, Volker Ziemann While the private banking industry is in general relatively well equipped on the tax planning side, with tools that can allow private bankers to analyse the situation of high net worth individuals operating offshore or in multiple tax jurisdictions, the software packages used on the financial simulation side often suffer from significant limitations and cannot satisfy the needs of a sophisticated clientele. In fact, most financial software packages used by private bankers to generate asset allocation recommendations rely on single-period mean-variance asset portfolio optimisation, a tactic that, for at least two reasons, cannot lead to proper strategic allocation. This study provides a formal framework suggesting that asset-liability management can ensure that private wealth managers are able to offer their clients investment programmes and asset allocation advice that truly meet their needs. A revisited version of this paper was published in the Fall 2009 issue of the Journal of Portfolio Management. More...
07/10/09
Alternative Investments
Noël Amenc, Lionel Martellini, Jean-Christophe Meyfredi, Volker Ziemann 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. A revisited version of this paper was published in the March 2010 issue of European Financial Management. More...
07/09/09
Alternative Investments
Noël Amenc, Lionel Martellini, Volker Ziemann This paper presents an empirical analysis
of the benefits of alternative forms of
investment strategies from an asset-liability
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. A revisited version of this paper was published in the Summer 2009 issue of The Journal of Portfolio Management. More...
20/03/09
Alternative Investments
Greg N. Gregoriou, François-Serge Lhabitant 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. A revisited version of this paper was published in the Summer 2009 issue of The Journal of Wealth Management. More...
09/02/09
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. A revisited version of this paper was published in the Winter 2009 issue of the Journal of Wealth Management. More...
17/12/08
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.
An article based on this survey was published in the Summer 2009 issue of the Journal of Alternative Investments. More...
23/07/08
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. A revisited version of this working paper was published in the Winter 2010 issue of the Journal of Alternative Investments. More...
20/05/08
Asset Allocation
Felix Goltz, Lionel Martellini, Koray D. Simsek This paper attempts to determine what fraction a static investor should optimally allocate to investment strategies with convex exposure to stock market returns in a general economy with stochastically time-varying interest rates and stock market excess returns. The results obtained using Monte Carlo analysis show that investors should allocate between 45% and 63% of their
portfolio to such portfolio insurance strategies. Moreover, the inclusion of portfolio insurance strategies leads to important utility gains. The results are robust with respect to the choice of the objective, the presence of realistic levels of market friction, heterogeneous expectations on volatility, and various parametric assumptions. A revisited version of this paper was published in the Journal of Investment Management, Vol. 6 Nº. 2, Second Quarter 2008. 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
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. A revisited version of this paper was published in the August 2009 issue of The Amercian Economic Journal: Economic Policy. More...
09/04/08
Indices
Lionel Martellini Following recent research on the relevance of idiosyncratic risk in asset pricing models, this paper proposes to use total volatility as a model-free estimate of a stock's excess expected return, and analyze the implications in terms of the design of improved equity benchmarks. It finds that maximum Sharpe ratio portfolios consistent with such expected return proxies, and built upon improved estimates of the correlation parameters, significantly outperform market cap weighted schemes on a risk-adjusted basis. This analysis, which rehabilitates the role of the tangency portfolio from modern portfolio theory, suggests that better equity benchmarks can be designed, provided that a sophisticated portfolio optimization procedure is used that relies on robust estimates of moments and co-moments of stock return distributions. This paper has important potential implications for the ongoing debate on appropriate weighting schemes for equity indices. A revisited version of this paper was published in the Summer 2008 issue of the Journal of Portfolio Management. More...
06/03/08
Alternative Investments
Noël Amenc, Walter Géhin, Lionel Martellini, Jean-Christophe Meyfredi 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
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
Lionel Martellini, Volker Ziemann 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
Lionel Martellini, Jean-Christophe Meyfredi 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
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. A revisited version of this paper was published in the February 2009 issue of the Journal of Asset Management. More...
22/08/07
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. A revisited version of this paper was published in the November/December 2009 issue of the Journal of Business Finance and Accounting. More...
04/05/07
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
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
Walter Briec, Kristiaan Kersten, Octave Jokung This paper proposes a nonparametric efficiency measurement approach for the static portfolio selection problem in mean-variance-skewness space. A shortage function is defined that looks for possible increases in return and skewness and decreases in variance. Global optimality is guaranteed for the resulting optimal portfolios. We also establish a link to a proper indirect mean-variance-skewness utility function. For computational reasons, the optimal portfolios
resulting from this dual approach are only locally optimal. This framework makes it possible to differentiate between portfolio efficiency and allocative efficiency, and a convexity efficiency component related to the difference between the primal, non-convex approach and the dual, convex approach. Furthermore, in principle, information can be retrieved about the revealed risk
aversion and prudence of investors. An empirical section on a small sample of assets serves as an illustration. A revisited version of this paper was published in the January 2007 issue of Management Science. More...
23/02/07
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. A revisited version of this paper was published in the June 2009 issue of Applied Financial Economics. More...
05/02/07
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. A revisited version of this paper was published in the March 2009 issue of the Journal of Futures Markets. 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
Transaction Cost Analysis
Jean-René Giraud, Catherine d’Hondt MiFID is the second step in the harmonization of the European capital markets industry and intends to adapt the first Investment Services Directive (ISD 1 issued in 1993) to the realities of the current market structures. After having clarified the nature of the new regulation, this paper first describes the role of Transaction Cost Analysis in the fulfilment of the best execution obligation as well as the limits of existing frameworks. Then, the paper presents a new methodology that makes it possible to measure the quality of execution as part of peer group review and identify whether the broker, trader or algorithm has implemented the execution too aggressively or too slowly. This approach relies on a couple of indicators allowing an easy comparison of a large universe of trades and providing insightful information not only about the final performance (EBEX absolute indicator) but also about the possible justification of the performance (EBEX direction). In order to illustrate both the framework and the level of interpretation made possible, the results of a preliminary study conducted on 2737 orders on Euronext blue chips over a 4-month sample period are reported. A revisited version of this paper was published in the November 2006 issue of the Journal of Asset Management. More...
06/10/06
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
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.
More...
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.
More...
02/08/06
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
Operational Performance
Rudy De Winne, Catherine D’Hondt This letter focuses on hidden orders and shows how they contribute to liquidity. Based on a rebuilt order book from Euronext data, the part of liquidity which is not disclosed to market participants is described and its determinants are analyzed. A revisited version of this paper was published in the July 2006 issue of Finance Letters. More...
07/07/06
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
Walter Géhin, Mathieu Vaissié 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
Indices
Joëlle Miffre The article shows that country-specific exchange-traded funds (ETFs) enhance global asset allocation strategies. Because ETFs can be sold short even on a downtick, global strategies that diversify risk across country-specific ETFs generate efficiency gains that cannot be achieved by simply investing in a global index open- or closed-end fund. Besides, the benefits of international diversification can be achieved with country-specific ETFs at low cost, with low tracking error and in a tax-efficient way. For all these reasons, country-specific ETFs may be considered serious competitors to traditional country open and closed-end funds. A revisited version of this paper was published in the March 2007 issue of the Journal of Asset Management. More...
31/05/06
Alternative Investments
Noël Amenc, Philippe Malaise, Mathieu Vaissié The development of alternative investment has not yet been accompanied by a genuine consideration of the specific characteristics of the risks and returns of hedge funds with regard to the provision of information to investors. This inadequacy came to light in a study published by EDHEC in 2003, a study that showed that a very large majority of European hedge fund managers were satisfied with a reporting method designed for investment in traditional asset classes. This method proposes a mean variance-structure that is inappropriate for the risk and return profiles of alternative investment and does not inform investors of extreme risk and risk factors affecting the different returns of the hedge fund strategies in which the funds of funds are invested. To address
this issue, in 2004, EDHEC launched, an international consultation process for the implementation of a new framework for funds of hedge funds reporting. A revisited version of this paper was published in the Journal of Risk Finance, 1st Quarter 2006. More...
06/04/06
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. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Alternative Investments. More...
16/03/06
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. A revisited version of this paper was published in the December 2006 issue of the Global Finance Journal. More...
16/08/05
Asset Allocation
Lionel Martellini, Branko Uroševic 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
Frank J. Fabozzi, Lionel Martellini, Philippe Priaulet 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
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
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, 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
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
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
Alternative Investments
Noël Amenc, Anne Delaunay, Jean-René Giraud, Felix Goltz, Lionel Martellini, Mathieu Vaissié 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
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
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.
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28/02/03
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
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
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
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
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...
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