New Asian research presented at EDHEC-Risk Days Asia 2012By Frédéric Ducoulombier, Director, EDHEC Risk Institute—Asia
The EDHEC-Risk Days Asia 2012, which were held at the Marina Bay Sands Hotel in Singapore on May 9 & 10, represented a successful introduction to Asia of EDHEC-Risk Institute's conference model of bringing research insights to investment professionals, with over 800 delegates attending. The Institute wished to enable participants to have access to the latest conceptual advances and research results in investment and risk management and to discuss their implications and applications with researchers who combine expertise in analytical and research methods with a sound awareness of their relevance for the investment industry.
On the first day, the conference focused on advances in equity investment and equity portfolio construction, and on passive investment and indexing.
The advances in equity investment discussed included both global issues–in particular, new approaches to equity portfolio construction, the protection of equity portfolios against sovereign risk, and optimisation of risk management via the combination of risk diversification, risk hedging and risk insurance–and topics with a distinctive regional dimension–notably, volatility management and downside risk control on Asian equity markets and the search for true Asian exposure on the region’s public equity markets.
In the presentation on protecting equity portfolios against sovereign risk, we proposed a methodology for designing a low sovereign risk equity index, based on a market-based measure of sovereign default risk. Our results show that the exposure to sovereign default risk differs widely across stocks, which enables the creation of portfolios that control exposure to this risk factor at the desired level. During weeks with the most pronounced upward spikes of sovereign CDS spreads, low sovereign risk equity portfolios incur much lower losses (with about a 41% annualised loss) than high sovereign risk equity portfolios, which have annualised losses of 65%.
At the height of the Eurozone sovereign debt crisis from June to September 2011, a low sovereign risk equity portfolio returned -8.54% with 21.45% volatility while a high sovereign risk equity portfolio returned -14.39% with 25.74% volatility, thereby showing a significant difference in performance.
The indexing and passive investment matters examined focused on Asia: the results of the first academic study of indices and passive management in Asia were unveiled, they documented the level of adoption of passive investment in the region and highlighted the latest trends in the use of indices by Asian investors. Among the notable findings presented:
- The results show that while indices are relatively widely used in all asset classes, satisfaction rates are moderate to low, especially for fixed-income indices, where fewer than 50% of respondents are satisfied with the indices they are using.
- While 65% of respondents judge equity sector indices to be important, only 47% see equity style indices as important for their investment process (despite academic evidence that style factors such as value and size have strong explanatory power for expected returns). Within the Asian investment universe, country indices also tend to carry more weight than sector indices – again surprising in the light of evidence on the diminishing potential for diversification across countries.
- More than 77% of respondents consider that corporate bond indices lack reliability in terms of interest rate and credit risk.
- Unlike investors in Europe and North America, Asian investors consider the risk-return properties of an index to be important when making the decision to adopt an index.
In a further presentation, the major Asian equity indices were evaluated in order to understand their biases, assess them for stability and efficiency and challenge their representativeness. Among the main results presented:
- All indices analysed display a pronounced lack of efficiency: compared to equal-weighted indices based on the same set of stocks, the standard cap-weighted indices underperformed by at least 2.22% annually.
- Asian equity indices also show severe fluctuations in style and sector exposures: for example, the weight of Telecom Services stocks in the Hang Seng index fluctuated between 8.56% and 27.68%. The weight of Consumer Staples stocks in the Indian Nifty Index fluctuated between 3.08% and 27.54%.
- EDHEC-Risk’s results also show that such indices are not representative of the Asian economy. Many index heavyweights derive less than a quarter of their sales from Asian countries, or have less than 50% of their assets or employees in the Asian region.
Regulatory development affecting ETFs in the region and alternatives to traditional equity indices were also reviewed and assessed.
A session on structured equity investment strategies for long-term Asian investors, drawn from research supported by Société Générale Corporate & Investment Banking, explored the empirical characteristics of Asian equity markets, compared the risk-return profiles of equity strategies when volatility is stochastic, and showed how to design structured equity strategies to capture the equity risk premium while managing total volatility and downside risk.
On the second day, the conference focused on alternative strategies and reviewed traditional, modern, and emerging alternative investments. EDHEC-Risk Institute researchers presented their latest results on the determinants of private equity performance, and hedge fund allocation, modelling and performance. They also discussed developments in infrastructure investing, presented a new class of volatility indices for Asia and evaluated skewness as an asset class.
In a presentation on next-generation commodity investing, EDHEC-Risk introduced research conducted with the support of CME Group on the implications for portfolio risk and market regulation of long-short commodity investing. The presentation looked at measuring the returns earned by long-short commodity investors, examined long-short commodity portfolios as a hedge against extreme equity risk, and asked whether long-short investors were destabilising commodity markets by increasing volatility and cross-market linkages. The research found no evidence that speculators, by taking long and short positions, have increased conditional volatility or conditional correlation with stocks and bonds. Calls for increased regulation of commodity futures markets might therefore be premature.
The next edition of the EDHEC-Risk Days Asia conference will be taking place on May 15-16, 2013 at the Ritz-Carlton Millenia, Singapore. More information on the conference can be found here.