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Miffre & Till State-of-the-Art Commodities Investing Seminar, New York, 21-22 October, 2008
CFA Institute/EDHEC Second Annual Advances in Asset Allocation Seminar, London, 17-19 November 2008
EDHEC Alternative Investment Days 2008, London, 9-10 December, 2008
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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. With an abnormal return of 21.02%, a novel double-sort strategy that exploits both momentum and term structure signals clearly outperforms the single-sort strategies. This double-sort strategy can additionally be utilized as a portfolio diversification tool. Interestingly, the abnormal performance of the double-sort portfolios cannot be explained by a lack of liquidity or data mining and is robust to transaction costs and to different specifications of the risk-return trade-off. 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. 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. 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. 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
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. 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. 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. 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. 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 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. 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. 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. 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. 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. 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.
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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.
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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. 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. 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. 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
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