Indexes
Oleg Ruban, Dimitris Melas. In view of the recent unprecedented volatility of UK equities, the authors examine the potential benefits, to UK investors, of international diversification. These benefits can be evaluated in terms of risk reduction and risk-return enhancement. More...
25/08/09
Indexes
Srikant Dash, Keith Loggie. The authors note that most indices created in the wake of the S&P 500, that is, since 1957, are capitalisation weighted, as recommended by the capital asset pricing theory and the efficient market hypothesis. At the same time, there has been controversy about the degree of efficiency of the market. In other words, a broad capitalisation-weighted index may not be the most efficient investment. More...
19/08/09
Sovereign Wealth Funds
Bortolotti, B., Fotak, V., Megginson, W. and Miracky, W. Investments made by sovereign wealth funds have come in for considerable public scrutiny. Although initial regulatory attempts to control sovereign investments are already underway, empirical evidence on the investment patterns of sovereign funds is scarce. Bortolotti, Fotak, Megginson and Miracky provide the most comprehensive empirical analysis of sovereign fund transactions to date. Their results yield interesting insights into the investment behaviour of sovereign wealth funds and their market impact.
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08/07/09
Indexes
Niklas Wagner, Elisabeth Stocker. Wagner and Stocker underscore the importance of having suitable benchmarks in terms of investment styles for portfolio performance evaluation. In this article, they introduce a new family of six European style indices, covering traditional styles introduced by Fama and French (1992) and Carhart (1997), namely beta, size, valuation and momentum, as well as two additional styles, idiosyncratic risk and illiquidity. The two latter indices are innovative, as idiosyncratic risk and illiquidity had not previously been considered themes for index construction. The construction of idiosyncratic risk indices was motivated by recent findings that show the importance of idiosyncratic risk, in addition to systematic risk, in asset prices (see Malkiel and Xu 2004; Goyal and Santa Clara 2003). Illiquidity was also identified as a determinant in asset pricing (see Amihud et al. 2005 for an overview). More...
07/07/09
Hedge fund performance
J. Joenväärä and H. Kahra. Can hedge funds’ characteristics be exploited to pick hedge funds? Is a characteristics-based strategy more profitable than a naïve strategy? Joenväärä and Kahra address these questions by using three hedge fund characteristics—managerial incentives, the length of the notice period, and fund size. This approach is derived from a previous paper by Brandt, Santa-Clara, and Valkanov (2008), who exploited the characteristics of equities to build an optimal equity portfolio. The authors’ work assumes that these characteristics impact hedge fund performance, as looked into by other studies that focus on explicit micro-factor models. More...
03/07/09
Indexes
Leonard Kostovetsky. The recent surge in popularity of ETFs (exchange-traded funds) has led to growing amounts of research into their advantages and disadvantages. But Kostovetsky notes that little of this research has compared the total costs borne by investors of the two comparable passive investment techniques, namely ETFs and index funds. The only study is that by Dellva (2001), who concludes that, because of brokerage commissions, ETFs are not attractive for small investors. But this study did not quantitatively model the differences in costs between the two. So, in the present article, Kostovetsky provides a quantitative comparison of the explicit and implicit costs incurred by ETFs and those of index mutual funds. More...
08/06/09
Indexes
Chen Chen, Rong Chen, Gilbert W. Basset. Cap-weighted indices were developed on the assumption that the market portfolio is mean-variance efficient. As the validity of this assumption has not been confirmed, however, alternative weighting systems have been proposed. Among them are the fundamental indices introduced by Arnott, Hsu, and Moore (2005). More...
25/05/09
Indexes
Remy Briant, Frank Nielsen, Dan Stefek. In this article, Briand, Nielsen and Stefek note that classic strategies of allocation to equities and bonds lead to portfolios with insufficient diversification and high volatility. As a result, investor portfolios are not protected from losses during downturns. It has recently been argued that alternative asset classes, such as private equity, hedge funds or commodities, improve portfolio diversification, but this additional diversification did not shield portfolio returns from the effects of the 2008 crisis. According to the authors, an ideal portfolio is composed of large numbers of return-producing units, the risks of which are independent of one another. More...
19/05/09
Bond Indices
Brown, Patrick J. At first sight, constructing, calculating, and maintaining a bond index does not appear very difficult. After all, equity market indices have existed for a long time. Since bonds are also traded securities, transferring the method of setting up equity indices to the bond universe seems straightforward. Still, bonds are different from equities in many respects. Bond markets are much more diverse than equity markets, bonds have a fixed maturity and the market thus changes swiftly, and bond trading volumes are much lower, especially for corporate bonds. More...
12/05/09
Sovereign Wealth Funds
Setser, B., and R. Ziemba The member countries of the Gulf Cooperation Council (GCC) boast some of the largest sovereign wealth funds in the world. Spurred by the high oil prices of recent years, these funds have invested heavily outside the Gulf region, but nearly all of them disclose little information about fund flows or investments and prefer discretion and inconspicuousness. Setser and Ziemba try to shed light on these funds. More...
20/04/09
Indexes
Patrick Behr, André Güttler, Felix Miebs. There are two interesting portfolios on the efficient frontier: the tangency portfolio and the minimum-variance portfolio. The minimum-variance portfolio is interesting because it does not require computation of expected asset returns, but only of the covariance matrix, which is more stable. Many researchers have estimated the performance of this portfolio and compared it to other portfolios and identified an advantage in terms of performance for this portfolio. More...
16/04/09
Bond Indices
Reilly, Frank K., G. Wenchi Kao, and David J. Wright As with stock market indices, there is a large variety of bond indices that aim to reflect the movement of broad bond markets or specific sub-segments. Many of these indices use different construction methodologies, rely on different bond pricing sources, or have different criteria for including bonds. So choosing the right index is important for any bond investor. However, from a practical perspective, the question is: does it really matter? Is there any significant difference in the indices or in the end are they all alike? More...
15/04/09
Performance
Berk A. Sensoy. New SEC regulations require mutual fund providers to present fund performance relative to a benchmark index in their prospectuses. Nonetheless, they are entirely free to choose the benchmark. So these benchmarks may not be pertinent in evaluating funds’ abnormal returns, i.e., the additional return that can be put down to the manager’s skill alone, not to the fund’s exposure to risk factors. According to the author, a benchmark may be chosen for marketing reasons, in such a way as to make performance appear most favourable, a choice made to generate additional subscriptions. More...
26/03/09
Hedge Fund Performance
J. Joenväärä and P. Tolonen. Joenväärä and Tolonen examine the relation between share restrictions and risk/performance, in the context of hedge funds. Share restrictions include the lockup period, the notice period, the redemption period, and the minimum investment. The lockup period is the period during which investors are not allowed to withdraw their shares. The notice period is the time the investor has to give notice to the fund about an intention to redeem money from the fund. More...
23/03/09
Indexes
John Eggins, Robert J. Hill. Eggins and Hill note that, although major index providers provide stock market indices, including market-cap weighted indices, large- and small-cap indices, value and growth indices, that can serve as proxies for the factors of the Fama-French (1992, 1993, 1996) model, no momentum and contrarian indices are computed to mimic these additional factors. As the Carhart (1997) four-factor model is widely used to measure investment performance, they suggest that momentum indices would be of great interest. So in this article Eggins and Hill introduce momentum and contrarian stock market indices based on the Russell 1000. More...
19/03/09
Bond indices
Arnott, Robert D., Hsu, Jason C., Li, Feifei and Shepherd, Shane D. Recent empirical work on “fundamental indexing” (Arnott et al. 2005) presents evidence that equity indices that are weighted by company fundamentals outperform standard market capitalization weighted indices. This finding has led to a controversy among financial economists on how to explain these higher returns. In this paper, Arnott et al. (2008b) transfer the idea of fundamental indexation to the fixed income universe. More...
12/03/09
Performance
Marie-Hélène Broihanne, Maxime Merli, Patrick Roger. More and more mutual funds are being made available, and investors need indicators to make their selection. Though past performance is not a reliable indicator of future performance, investors often use it as a criterion for selecting funds. The authors first provide a brief review of performance measurement. Over the years, great efforts have been made to develop performance measures—Sharpe ratio, Sortino ratio, Treynor ratio, Jensen’s alpha—that integrate both risk and return. More...
16/02/09
Indexes
Michael Edesess. In this article, Edesess analyses the arguments of fundamental indexing promoters to see if they hold up. Fundamental indexation appears to be a strategy consisting of value-tilting stock portfolios. Its promoters have introduced this new form of index weighting as an alternative to capitalisation weighting, which was said to overweight overpriced stocks and underweight underpriced stocks. Several authors, including Arnott and Hsu (2008), Hsu (2006) and Treynor (2005), have attempted to mathematically prove this over-weighting/under-weighting argument. Other authors, including Kaplan (2008) and Perold (2007), have criticised these proofs, underlining that part of the demonstration assumed that the fair values of stocks were known by the asset allocator. In fact fair values are not known. They are not observable, not even a posteriori. More...
27/01/09
Hedge Fund Performance
S. Darolles, C. Gouriéroux. Gouriéroux and Darolles propose a methodology to compute Sharpe performance measures for hedge fund rankings. They present a conditionally fitted Sharpe performance measure, so called because it is an “investor driven” performance measure. In other words, it is an attempt to take into account, for example, the initial holding or the investment horizon of the investor. Each investor could therefore have his own fund ranking, depending on his investment environment. More...
10/12/08
Hedge Fund Replication
N. Papageorgiou, B. Remillard and A. Hocquard. The authors propose an extension of the payoff-distribution approach, one of three possible replication approaches, along with the factor-based and rules-based approaches. The authors propose a modified version of Kat and Palaro’s method, arguing that it remedies some of the shortcomings. In their view, one of the weaknesses of Kat and Palaro’s method comes from the use of a Black-Scholes framework that ignores the higher moments of the distributions, while “the hedge fund returns and traded assets are clearly non-normal”. More...
02/11/08
Indexes
Sébastien Maillard, Thierry Roncalli, Jérôme Teiletche. Maillard, Roncalli, and Teiletche first underline the drawback of Markowitz optimisation models for deriving optimal portfolios: the portfolios are concentrated in a limited number of assets, and the result is very sensitive to the inputs. Investors apparently prefer alternative heuristic methods, including minimum variance portfolios and equally weighted portfolios. These alternatives seem easier to implement and are also more robust, as they do not depend on expected asset returns. More...
13/10/08
Hedge Fund Performance
C. Brooks, A. Clare, and N. Motson. Brooks, Clare, and Motson look into whether an examination of pre-fee (gross) or post-fee returns (net) is more appropriate to an analysis of hedge fund risk and performance. In addition to management fees, which usually range from 1 to 3% of assets under management, hedge funds charge incentive fees. Incentive fees depend on profits, not on assets under management, and are charged if the return clears a hurdle and if the fund value is above a high-water mark. More...
27/08/08
Indexes
Frederick E. Dopfel. The author first recalls the important difference between active and passive management, i.e., that if an active fund outperforms, there is necessarily another fund that underperforms, while investors in passive cap-weighted indices accept average investment returns, rather than take the risk of earning inferior returns. The recently introduced fundamental indices look more like active strategies than passive indices, since they seek to outperform cap-weighted indices. In this article, the author proposes to identify the specific conditions in which one would do well to invest in fundamental indices. More...
14/08/08
Indexes
David Blitz, Laurent Swinkels. Fundamental indices are indices whose constituents are weighted by fundamental indicators. The possible superiority of these indices to cap-weighted indices has sparked animated debate. In this article, the authors compare the construction and performance of fundamental indices and cap-weighted indices. More...
13/08/08
Indexes
Dr. Thomas Neukirch. In this article, Neukirch looks into two alternative methods to cap-weighting for index construction. He suggests constructing two equivalents to the MSCI World Developed Markets Index, an index made up of about 1,950 constituents. Equal weighting and equal risk weighting are used to weight the constituents. Monthly data from February 2001 to January 2008 are used to complete the study.
Equal risk weighting involves weighting all constituents in such a way that each contributes the same amount of risk to the resulting portfolio. The risk measure used is volatility. In addition, the author also considers modifications of these weightings with respect to countries and sectors. More...
13/08/08
Performance
Chris Adcock. This article considers two measures of portfolio risk: the beta from the CAPM and the measure of portfolio risk introduced by Rubinstein (1976). The appropriate measure of portfolio risk is important, as it will determine the value of alpha in portfolio performance measurement. The traditional CAPM assumes that asset or portfolio returns are distributed according to an elliptical symmetry. But this is not so for all assets or portfolios. In particular, assets tend to exhibit skewness. To deal with the problems associated with estimates of alpha using CAPM beta, Leland (1999) proposes a measure of risk referring to Rubinstein’s (1976) asset pricing model, which takes into account the possible existence of asset return skewness, making it potentially attractive for portfolios including options. More...
07/07/08
Indexes
Sanjay Arya, Paul Kaplan. Arya and Kaplan note that capitalisation weighting, which appears to be a good weighting system from a theoretical point of view, is not without drawbacks. One of the drawbacks of cap weighting indices is that they often end up exposed to the more overpriced assets, which can possibly reverse and cause losses. As an alternative, some have turned to fundamental indexation, in which assets are weighted by measures of size such as revenue, book value, and dividends. Fundamental weighting may remedy some of the drawbacks of cap weighting, but it can also lead to value and small-cap biases, higher turnover, higher costs, problems of scalability, and macro inconsistency. More...
30/06/08
Investment Management
F. J. Fabozzi, S. M. Focardi, and C. Jonas. In April, Fabozzi, Focardi, and Jonas published the results of a survey of trends in quantitative equity management. The survey participants are 31 asset managers. 15 are US-based, and 16 are located in Europe. They manage $2.194 trillion in equities. Two types of investment processes are distinguished. First, the fundamental, or judgmental, investment process, which is based on human decisions. Second, the quantitative, or automated, investment process, in which decisions are computer-driven. More...
23/06/08
Indexes
Martijn Cremers, Antti Petajisto, Eric Zitzewitz. Cremers, Petajisto, and Zitzewitz note that passive indices, such as the S&P 500 or the Russell 2000, widely used as benchmarks in portfolio management, exhibit abnormal statistically significant returns – whether positive or negative – relative to the Carhart four-factor model. In their view, these abnormal returns suggest that this model does not correctly take into account all the factors that explain asset returns. As a result, the alpha from this model will not correctly evaluate managers’ portfolio performance: they will be credited for performance stemming from their exposure to passive indices or they will be penalised for it. More...
18/06/08
Indexes
Paul D. Kaplan. In this article, Kaplan makes his contribution to the debate between the supporters of fundamental-weighted indices and those of capitalisation-weighted indices. For Kaplan, fundamental indexers have based their theories on questionable assumptions. In this article, he examines the underlying theory of fundamental indexation from the point of view of fair value multiples, unobservable numbers that make it possible to equate the fair value of a stock, also unobserved, to some observed measure of the stock’s fundamental value. Like Hsu (2006), he assumes that a stock’s market value differs from its fair value by an independent multiplicative error term. More...
05/05/08
Hedge Fund Performance
S. Hossain, L. T. P. Nguyen, M. O. Sy, and C. M. Yu. The measure of performance persistence attempts to answer the following question: do winners and losers repeat? While an extensive literature is now available on hedge fund performance persistence, the study by Hossain, Nguyen, Sy, and Yu has two specificities. First, it focuses on Asian hedge funds. Second, it takes methods that other studies have used in two-period frameworks and uses these methods in a multi-period framework. Theoretically, a multi-period framework has the advantage of reducing the likelihood of observing persistent “hot hands” that are in fact the result of chance. More...
10/04/08
Performance
Yin-Ching Jan, Su-Ling Chiu. Persistence in mutual fund performance is of great interest to investors; indeed, it can determine their choice of investment. Numerous studies have used different methods of performance measurement to investigate the possible existence of persistence in fund performance. In the present article, Jan and Chiu examine whether the results depend on the measure used.
They use a data sample including 228 equity funds from the Taiwan Economic Journal Mutual Fund Database. The data cover a period beginning in January 1993 and ending in December 2004. The database includes defunct funds. Jan and Chiu evaluate fund annual performance using several methods. More...
08/04/08
Indexes
André F. Perold. Some authors have used the noisy market hypothesis to assert that weighting indices by market capitalisation has resulted in performance worse than that of strategies using other weighting schemes. For these authors, market-cap weighting over-weights overvalued stocks and under-weights undervalued stocks. The value of overvalued stocks will tend to decrease until it reaches its true value, a phenomenon that will lead to poor performance for the cap-weighted index. As an alternative, they have developed what are called fundamental indices, in which stocks are weighted by the value of their fundamental characteristics rather than by their market capitalisation. More...
08/04/08
Style analysis
Arik Ben Dor, Vernon Budinger, Lev Dynkin, Kenneth Leech. In this article, the authors stress the importance of being able to accurately evaluate the performance of mutual funds. The performance of funds is generally evaluated relative to a benchmark. Most of the time, however, the methodology used to derive the benchmark does not make it possible to have a suitable representation of the fund to be evaluated. The authors mention the use of a single index as a representative benchmark, which does not allow representation of all the asset classes a fund may be invested in. Another more sophisticated approach involves building a benchmark based on mutual fund holdings. In this case, the problem will be collecting the data, as it is difficult to obtain accurate information on fund holdings on a regular basis.
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18/03/08
130/30 Strategy
S. Ericson, G. Johnson, and V. Srimurthy. Ericson, Johnson, and Srimurthy, three portfolio managers, publish one of the first empirical comparisons of the performance of 130/30 funds and that of long-only strategies. These comparisons, complicated by recent launches and short track records, have hitherto been made from a largely theoretical perspective. To get around these complications, the authors opt for back tests in which the performance of 130/30 funds is simulated by applying quantitative trading rules. More...
19/12/07
Hedge Fund Performance
A. Grecu, B. G. Malkiel, and A. Saha. Why do hedge funds stop reporting performance? According to Grecu, Malkiel, and Saha, there are two possible explanations. First, funds stop reporting when they underperform their peers. Second, they stop when they do not need to attract additional capital. Through performance comparisons, hazard rate computations, and the identification of factors increasing the risk of reporting failure, the authors attempt to determine the more likely of the two possible explanations. More...
06/12/07
Indexes
Javier Estrada. The author points out that, most of the time, whether they serve for passive or active management, benchmarks are capitalisation-weighted, on the assumption that the market portfolio is mean-variance efficient. Meanwhile, academics and practitioners tend to seek strategies to outperform the market over the long term. Among them is fundamental indexation, which weights assets by fundamental measures of value, such as dividends. In this article, author Estrada investigates which capitalisation or fundamental measure, among capitalisation or fundamental measures, is the best one to weight country index funds and ETFs when building global portfolios. More...
25/10/07
Indices
Steven Schoenfeld, Robert Ginis. In this article the authors describe the various alternatives to cap-weighting systems recently developed for index construction, underlining that they in fact consist of active management strategies and do not lead to indices that may serve as benchmarks or represent an asset class.
The reason that index providers are developing alternative-weighted indices is to achieve higher returns in investment management. Different approaches are used to construct these indices. Some specifically try to isolate one or more factors that have been shown historically to outperform the market, while others attempt to redefine what size means to the market. Some even specifically target alpha-producing patterns and integrate them into their index methodology. More...
10/10/07
Alternative Investments
Daniel P.J. Capocci. The aim of this analysis of hedge fund strategies is to understand how managers make or destroy value. Capocci has developed a multi-factor performance and persistence analysis model and used it over several time periods. He also analysed the neutrality of hedge funds against equity markets in order to validate hedge fund managers’ claims that they are market neutral. Finally, he developed new efficient frontier measures, which not only include returns and volatility, but also skewness and kurtosis in order to determine whether hedge funds are really beneficial to investors. More...
13/09/07
Indexes
S. Gowri Shankar. Gowri Shankar notes that not all index funds can be considered passively managed funds since stock indices themselves are constructed and maintained in different ways. According to Sharpe’s (1991) definition of a passive index, the Russell indices, which are constructed solely on the basis of their market capitalisation, are passively constructed, while the S&P indices are actively constructed by an index committee at Standard & Poor’s that chooses firms using discretionary criteria. Nevertheless, these indices are typically considered substitutes, despite the differences in their construction. More...
27/08/07
Indexes
Olfa Hamza, Mohamed Kortas, Jean-François L’Her, Mathieu Roberge. In this article, the authors take note of the criticism of the cap-weighting systems used by international equity indices and seek the best weighting system for these indices. To that end, they construct hypothetical indices of the MSCI EAFE countries (over the period from 1970 to 2000) to examine the relative performance of the weighting schemes of the MSCI EAFE index. The authors examine the effectiveness of GDP-weighting and equal-weighting as solutions to the over-concentration inherent to cap-weighting. They note that no specific model in portfolio theory supports GDP-weighting. More...
27/08/07
Performance
Ronald Best, Charles W. Hodges, James A. Yoder. Sharpe ratios based on realised returns provide a ranking of the past performance of portfolios, but many investors use these ratios when making investment choices. This use assumes that the portfolio return distribution is stable over time—that is, that the historical returns can predict future performance. In addition, Sharpe ratios are usually estimated using short-term intervals, e.g., the previous 36 monthly returns for Morningstar. The assumption is that investors also have a corresponding investment horizon and use the same return frequency.
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27/08/07
Hedge Fund Performance
A. Bandopadhyaya and J.L. Grant. In their “Survey of Demographics and Performance in the Hedge Fund Industry,” authors Bandopadhyaya and Grant scrutinise hedge fund domiciles, hedge fund manager locations, and the risk-adjusted performance of these funds. Performance was calculated over the twelve years from 1994 to 2005. This period is of particular interest, as it is composed of a bullish (for the stock market) sub-period from 1994 to 1999, and a bearish sub-period from 1999 to 2005. It is thus possible to see how hedge funds fare in different market environments. More...
09/08/07
Performance
Roman Kräussl, Ralph Sandelowsky. In this article, Kräussl and Sandelowsky take into account successive improvements in Morningstar’s fund ratings—originally established in 1985—in order to investigate the predictive performance ability of these ratings. Initially, funds were rated within broad asset classes. In July 2002, Morningstar changed the risk-adjusted return measure used to evaluate fund performance. Since then, they have also been rating funds within 64 narrower fund categories. It appears that many investors base their choice of funds on the fund’s previous rating.
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18/06/07
Performance
Craig L. Israelsen, Gary F. Cogswell. Israelsen and Cogswell argue that the use of tracking error as an indicator of fund performance is not suitable for active managers. They note that the concerns of fund managers over tracking error are related to the fact that their performance results are always compared with benchmark indexes, making them afraid to drift from their benchmark. More...
19/04/07
Style Indexes
Vesa Puttonen, Tatu Seppä. Style investment is now an essential concept that plays a major role in investment analysis and performance evaluation. Concerns over style have led to the construction of more sophisticated benchmarks that are suited to style investors, although this has only occurred quite recently in Europe. While the first style indices, including the FTSE and MSCI style indices launched in 1997, were based on price-to-book as the only style variable, the latest developed indices use several variables in defining growth and value. More...
12/04/07
Hedge Fund Performance
T. Schneeweis, H. Kazemi, and V. Karavas. While the replication of hedge fund performance is a subject that is in vogue in the alternative industry, academic papers began to deal with this issue several years ago. In this paper, Karavas, Kazemi and Schneeweis explore the factor approach. They examine the replication of equally-weighted portfolios of European-based hedge funds for 5 strategies, namely Funds-of-Funds, Convertible Arbitrage, Fixed Income Arbitrage, Event Driven and Long/Short Equity. More...
22/01/07
Indexation
Jared Kizer. In “Index Fundamentalism Revisited”, Reinker and Tower (2004) find that a synthetic portfolio of Vanguard’s actively managed U.S. equity funds outperformed a synthetic portfolio of its U.S. equity index funds from 1977 through 2003 by about 0.8 percentage points per year. The synthetic portfolio of active funds was also less volatile than the synthetic portfolio of index funds. The present article is an extension to the Reinker-Tower study that explains these U.S. results and discusses the relevance of the findings for the future performance of active funds versus passive funds. More...
13/12/06
Indexation
Carol Alexander, Anca Dimitriu. Traditionally, benchmark replication is performed by minimizing the variance of the portfolio tracking error. Alexander and Dimitriu underline the drawbacks of this methodology. The first one is that minimizing tracking error with respect to an index may result in a very sample-specific portfolio, unstable under volatile market circumstances. In addition, correlation measure is only convenient for stationary variables. Finally, depending on the model used to estimate it, correlation can be very sensitive to the presence of outliers, non stationarity, or volatility clustering, which limit the use of long data history and can lead to erroneous conclusions about the nature of long term dependencies. The alternative proposed is to use co-integration. More...
13/12/06
Style Analysis
J. Rekenthaler, M. Gambera and J. Charlson. Style analysis is the key point in comparing a fund against a peer group of funds, and finally in evaluating the performance of a given manager. Style analysis has been developed through two leading approaches, namely the Portfolio Based Style Analysis (henceforth PFSA) and the Return Based Style Analysis (RBSA). PFSA is a holdings-based analysis. More...
12/12/06
Indexes
Robert Fernholz, Robert Garvy and John Hannon. The authors begin by identifying the desirable properties of an index to be used as a reference in an equity indexing strategy. The first such property is that it should be broadly based and hold a representative selection of a given class of equities. The second is that the selection and weighting of the securities in the portfolio are objectively established and are not dependent on individual managers. The third is minimal portfolio turnover. In addition, for asset allocation purposes, it is important that the index represents a recognisable sector of the whole equity market. It appears that most institutional index funds follow capitalisation-weighted indexes. More...
14/11/06
Indexes
Alejandro Murguia, Dean T. Umemoto. Index funds represent a significant part of mutual fund assets, and indexing is also widely used by institutional investors. This type of investment is favourably considered by individual and institutional investors for the following reasons: it provides diversification; it has lower costs; it targets the desired market; it provides a benchmark to measure performance; it is less risky; and it provides superior returns, although this last attribute is subject to debate. However, indexing has some significant flaws that advisers should seriously consider before using them in a client’s portfolio. More...
09/11/06
Hedge Fund Performance
J. Hasanhodzic and A.W. Lo. Due to the very frequent criticism aimed at hedge funds, such as their lack of transparency, lack of liquidity or excessive fees, the replication of hedge fund returns is receiving increasing interest from academics. Kat and Palaro, for example, have introduced a copula-based approach. However, Hasanhodzic and Lo choose a more traditional approach based on a linear regression model. They argue that the copula-based approach fails as it is “more complex than the hedge fund strategies they intend to replicate.” More...
02/11/06
Indices
Frank K. Reilly, David Wright. In this article, the authors investigate the various small cap indexes available and compare their respective characteristics. The indexes considered are the Dow Jones Small Cap, the Ibbotson Small Cap, the Russell 2000, the S&P Small Cap 600, the Wilshire Small Cap 1750 and the Wilshire Micro. These six indexes include fairly large samples (600 to 2,400 stocks). They are all market value-weighted and have similar distributions of stocks to the major stock exchanges. However, these indexes differ in terms of median firm size and especially maximum firm size, which varies from about $250 million to over $4 billion. The period investigated is from 1984 to 2000. More...
31/10/06
Mutual Fund Performance
H. Qi and M. Alikakos. Qi and Alikakos propose a comparison of the risk-adjusted performance generated by closed-end and open-end mutual funds. Closed-end funds sell a predetermined number of shares at a given time and generally do not buy their shares back, while open-end funds continuously sell their shares and consequently have to keep large amounts in cash or in money market vehicles. Given these characteristics, closed-end funds should intuitively outperform open-end funds. However, this requires confirmation by empirical results. More...
05/09/06
Mutual Fund Performance
S. Lee and S. Stevenson. Real estate funds are mutual funds that invest in equity securities of companies engaged in the real estate industry. In this study, Lee and Stevenson assess the selection and timing ability of 19 UK real estate funds, from the 1st quarter of 1991 to the 3rd quarter of 2001. The point that is of particular interest is the comparison between the results obtained through traditional models and through meta-analysis. The traditional models used are the Treynor and Mazuy (1966) quadratic model and two specifications of the dual-beta model of Henriksson and Merton. The Treynor and Mazuy quadratic model improves the CAPM, by adding the measure of market timing ability to the measure of selection ability. More...
24/08/06
Currency Strategy Performance
M. Huttman and L. Harris. Huttman and Harris, two London-based specialists of currency programs, highlight that the impact of currency risk in equity and bond portfolios is non-negligible. For example, focusing on equity portfolios in EUR, USD, JPY, GBP, and CHF, they show that currency risk represents about a fifth of the total risk. Then, they distinguish two ways in which to manage the currency risk. The first way consists in neutralizing the currency risk. The second consists of active currency management. According to the authors, this type of strategy is of particular interest, because “the opportunity to generate positive returns exists in all market environments.” More...
18/08/06
Indexes
Paul Demskie, Francis Gupta. It is common practice for investors to split their domestic equity allocation between equity size (large/mid/small) and styles (growth/value). Whether they use passive or active management, they select an index or a benchmark to guide their style allocation. Most of them are then convinced that their portfolio is exposed to the style they seek. In this article the authors warn investors to be cautious in their index or benchmark choice, because this choice will determine their style exposure.
They observe that different style benchmarks, which are supposed to describe one style, exhibit very different month-to-month performances. More...
08/08/06
Mutual Fund Performance
Steven Kaplan, Berk Sensoy. Kaplan and Sensoy study the benchmark-timing ability of mutual funds. Timing tests are conducted in two ways. First, benchmark-timing ability is tested by considering changes in the portfolio weight on cash. Second, benchmark-timing ability is tested by scrutinizing changes in the benchmark beta of the equity portion of the portfolio. The authors stress that it is the benchmark-timing ability, not the market-timing ability, that is examined. They focus on benchmarks that are self-designated by mutual funds in their prospectus, to respect the SEC requirement introduced in 1998. More...
28/07/06
Indexes
John Southard, Bruce Bond. Southard and Bond explain that indices were created to measure price movements in the markets and were not intended to become investment supports. As a result, most market indices do not appear to be suitable to serve as benchmarks. First, the market-cap or float-weighted construction of most indices creates a stock-specific risk problem, due to lack of diversification. The second limitation of conventional indices is that the stocks selected to enter indices are not evaluated in terms of their performance. Stocks are placed in the index regardless of their investment value, creating embedded valuation risk when used as investable portfolios. More...
30/06/06
Indexation
Françoise Charpin, Dominique Lacaze. The authors note that for the purposes of both active and passive management, it may be useful to hold only a limited number of the benchmark assets. This may avoid holding very small and illiquid positions in portfolios, and limits administration and transaction costs. This subject has already been considered by Jansen and van Dijk, who proposed to use a diversity measure to deal with constraints on the number of stocks in a portfolio. According to Jansen and van Dijk, finding the exact solution to the optimization problem, including constraints on the number of stocks, would not be possible in most cases. In the present article, Charpin and Lacaze propose modelling which allows them to introduce such a constraint and to provide an exact solution to the problem. More...
16/06/06
Indexes
Craig L. Israelsen. Since a large number of equity style indices exist, it is tempting to compare their performance. In a previous study, Tweddell (2003), looking at the performance differences among various small-cap indices, underlined that the choice of the index used as benchmark makes a considerable difference in judging fund performance. As a result, it may be possible for a mutual fund company to do what Israelsen calls “benchmark shopping”, which consists of choosing to compare its funds to the index with the worst performance, among a set of indices, in order to make its own funds look better. More...
13/06/06
Indexes
Moshe Milevsky, Andrew Aziz, Al Gross, Jane Thomson, David Wheeler. Considering the case of social responsibility investment, where some companies are discarded from a portfolio because of their lack of social responsibility, the authors propose an optimization method to find the optimal portfolio weights for the remaining assets in order for the portfolio performance to be as close as possible to that of the portfolio that does not eliminate assets. To illustrate their procedure, they consider the Canadian S&P/TSX 60 index and apply a screening process to the index based on Corporate Social Responsibility (CSR) criteria. More...
09/05/06
Indexes
Harry M. Kat. Indexation appears to be a very popular investment strategy, concerning 20 to 40% of institutionally managed assets. The idea behind indexation is that markets are efficient and that the best way to perform well is to passively hold a diversified index. However, Kat notes that indexation is not necessary an optimal investment if one considers that stock market indices are created to reflect stock market movements and not to be good investments. Stocks are not selected based on their expected future performance or risk-return profile but simply on market capitalization. As a result, the composition of indices tends to be quite unstable, and the stock weights change continuously. More...
09/05/06
Indexes
Jack Treynor. In this article, Treynor again considers the problem of designing a good index for indexation. He defines what he calls market-valuation-indifferent (MVI) indexing as being indexing in which the index is built on any weights that avoid the problem of market capitalization. It appears that stock markets price stocks imperfectly, but on average overpriced stocks counterbalance underpriced stocks, resulting in a symmetrical distribution of error. If market value is used for index construction, more weight is given to the stocks with positive price errors, while stocks with negative price errors receive less weight. More...
14/04/06
Indexes
Hamish Seegopaul, Francis Gupta, John Prestbo. The authors note that the choice of benchmark plays a considerable role in portfolio performance. Benchmarks serve to identify portfolio alpha and for that purpose they are expected to be efficient. Moreover, benchmarks are expected to be representative, measurable and replicable. Finally, benchmarks should be information-free, resulting in zero average alpha for a large population of managers over a long period. This paper investigates domestic large-cap equity benchmarks, which are identified as being of major interest for plan sponsors. More...
10/04/06
Indexes
Robert D. Arnott, Jason Hsu, Philip Moore. The authors note that most investment management relating to indexes uses capitalization-weighted indexes, even though many academic papers have rejected the hypothesis that cap-weighted indexes are mean-variance efficient and suggested the existence of more efficient indexes. In this article, Arnott, Hsu and Moore propose to use fundamental metrics to weight indexes and demonstrate that these indexes are more efficient than cap-weighted-indexes. The authors note that cap-weighted indexes have some good characteristics, which should be preserved in any other weighting system. First, capitalization-weighting is equivalent to a passive strategy and consequently requires no rebalancing. Transactions will be limited to constituent replacement. More...
05/04/06
SRI Performance
Michael Schröder. SRI investment, while still small in absolute terms, is a growing part of investment in many countries. Numerous studies have investigated the performance of SRI investment funds compared to conventional funds without finding a significance difference between the two, even though one would expect lower returns from SRI funds due to the reduction in the investment universe from the screening process. In this article Schröder analyses the effect of SRI screening on portfolio performance. Unlike previous studies, he chooses to consider SRI indexes rather than SRI funds, to avoid dealing with transaction costs, market timing and fund management skill effects in measuring performance. More...
30/03/06
Indexes
Jason C. Hsu. Hsu begins by recalling why it is interesting to choose cap-weighting to construct portfolios. First, cap-weighting is equivalent to a passive strategy and thus requires no active management, resulting in no active management fee. Second, cap-weighted portfolios are automatically rebalanced as security prices fluctuate. Therefore, rebalancing costs are restricted to portfolio constituent replacement. Third, as there is a high correlation between market capitalization and liquidity, cap-weighting, which assigns the largest weights to the biggest companies, ensures that the portfolio is mostly invested in highly liquid stocks. More...
14/03/06
SRI Performance
Rob Bauer, Jeroen Derwall, Rogér Otten. The number of socially responsible mutual funds available is growing rapidly. It has been argued that this type of investment should tend to have lower returns than conventional investment because of restrictions in asset selection and the additional costs for asset screening. However, previous studies have not concluded that there is a significant difference in performance between ethical and conventional funds. More...
09/03/06
Indexes
Chih-Wei Huang. As indexation is growing, investors are becoming more and more concerned with the way indexes are built, including their weighting methodologies. Various weighting systems have been experimented with in the past. The first index, the Dow Jones Industrials Index, was price-weighted. Later, market-capitalisation weighted indexes were considered the best way to obtain accurate market representation with limited turnover. However, this did not solve one of the most important points to focus on when deriving an index, according to Huang, which is liquidity. More...
27/02/06
SRI Performance
Rob Bauer, Kees Koedijk, Rogér Otten. The social awareness of investors has led to an increase in the development of ethically managed mutual funds and caused academics and practitioners to investigate the consequences in terms of investment performance of this specific choice. Most of the studies conducted on the subject have concerned either US or UK funds, and have only been based most of the time on the consideration of simple indicators like the Sharpe and Treynor ratios and Jensen’s alpha. In most cases, the conclusion was that there were no statistically significant differences between the returns of ethically screened and unscreened universes. More...
22/02/06
Indexes
Jason C. Hsu, Carmen Campollo. Indexing appears to be an easy, inexpensive way of carrying out equity investment. Sharpe’s Capital Asset Pricing Model, by suggesting that a cap-weighted market index is an efficient equity investment, contributed to the popularity of index investing and to the development of exchanged-traded funds. However, capitalisation weighting, which is the weighting most commonly used by market indices, is not the best way for a portfolio to achieve good performance. Previous studies have underlined that cap-weighted indexes underperform non-cap-weighted portfolios with similar risks. More...
22/02/06
SRI Performance
Michael Schröder. With the growth in socially responsible investments in recent decades, many studies have investigated whether SRI funds, which are subject to restrictions in terms of asset choice, can reach equivalent performance levels to those of unrestricted funds. Schröder begins with a recap of the main studies that have been performed on the subject of SRI fund performance, recalling the different markets and periods investigated and the various methodologies used. Most of them have concluded that there is no significant difference between the performance of SRI funds and the performance of traditional funds. More...
06/02/06
SRI Performance
Bert Scholtens. Socially Responsible Investment (SRI) has grown considerably during the past few years, not only in the United States, but also in most developed markets. Scholtens notes that most of the studies performed on SRI fund performance have considered the US markets, while few studies have looked at other markets. He underlines that the Dutch market is an interesting one to study as it is one of the European markets with the highest percentage of SRI in overall investment. More...
30/01/06
Performance
Ammann and Moerth. Ammann and Moerth study the relationship between fund size and performance. The conclusions could be useful in constructing an explicit micro-factor model, where fund characteristics are selected as return factors. A significant relationship between fund size and performance can lead to fund size being included in an explicit micro-factor model. More...
09/11/05
Performance
Lars Jaeger. Jaeger argues that modelling returns of hedge fund indices can give reliable results, in spite of the shortcomings of the indices. This is due to the fact that the shortcomings only impact absolute performance measurement, and not the risk characteristics.
To model each hedge fund strategy, a macro explicit factor model is used, including linear and non-linear factors. For each strategy, the dependent variable is the corresponding return of the hedge fund index, provided by Hedge Fund Research. Returns are regressed from January 1994 to December 2004. An autocorrelation factor is added to take into account persistent price lags in the valuation of hedge funds. The regressions result in a wide range of R². More...
29/10/05
Funds of Hedge Funds
Emily Denvir, Elaine Hutson. Despite the recent phenomenal growth in funds of hedge funds, there has been only a limited amount of research on their performance – most of the academics seem to focus on individual hedge funds. In this paper, Emily Denvir and Elaine Hutson are filling the gap by analyzing the performance and diversification potential of a sample of 332 funds of hedge funds (FOHFs) for the period from January 1990 to May 2003. Consistent with prior studies, the authors find that over the considered period, funds of hedge funds appear to underperform a hedge fund index on a risk-adjusted basis. These sorts of findings are usually explained by the ‘double fee’ structure inherent in funds of hedge funds. More...
30/08/05
Performance
R.G. Ibbotson and P. Chen. Chen and Ibbotson propose a study on two subjects that are now well-documented in the hedge fund area, survivorship and backfill biases on the one hand, and the sources of returns on the other. The database, provided by TASS, covers January 1994 to March 2004. Funds of funds are excluded. The sample contains 2,054 live funds and 1,484 dead funds. In order to estimate the survivorship and backfill biases, six sub-samples are formed: live funds only with backfill data, live funds only without backfill data, live and dead funds with backfill data, live and dead funds without backfill data, dead funds only with backfill data and dead funds only without backfill data. More...
17/08/05
Performance
C. Alexander and A. Dimitriu. Alexander and Dimitriu study switching hedge fund strategies. This involves the fact that return distributions and/or exposures to risk factors and/or alphas depend on the regime, which could be the market environment. The following example of switching is given: a long/short equity strategy is long during bull markets and short during bear markets. According to the authors, linear models cannot take switching strategies into account. They propose the use of a Markov switching model. Two types of models are used: a single factor model and a two-factor model. More...
10/08/05
Performance
Greg N. Gregoriou. Survivorship bias is one of the potential biases that affect databases. Survivorship bias occurs if the database only contains information on “surviving” funds. Since this bias has a positive impact on returns, it is interesting to analyse the mortality of funds as part of performance measurement. In this paper, Gregoriou conducts a survival analysis that focuses on the market neutral and event driven strategies. The data used, provided by Zurich Capital Markets, covers the period from January 1990 to December 2001. It contains 325 live and 205 defunct market neutral funds and 142 live and 71 defunct event driven funds. The effects on survival time of several predictor variables are examined. These covariates are average monthly return, average millions managed, age, performance fees, management fees, leverage, redemption period and minimum purchase. More...
30/06/05
Performance
Craig L. Israelsen. Two simple performance indicators are often used to rank funds. The first one, the Sharpe ratio, was introduced by Sharpe (1966). It estimates the fund's excess return with regard to the risk-free rate divided by its standard deviation. The second one, the information ratio, is defined in a similar way by replacing the risk-free rate with a benchmark portfolio. The denominator of this ratio is therefore the fund's tracking-error. Israelsen points out that these two indicators may lead to spurious fund rankings when excess returns become negative. In that case, the fund with the higher ratio is not always the best one. The author illustrates this assertion with an example. As the issue is the same for the Sharpe ratio and the information ratio, numerical examples are presented for the information ratio only. More...
24/06/05
Performance
Arun S. Muralidhar. The development of risk-adjusted performance measures is a major research theme. In this article, Muralidhar first gives an overview of the various existing measures. The first two measures developed were the Sharpe ratio and the information ratio. These measures were criticised by Modigliani and Modigliani (1997) for not putting a figure on the amount of return and not giving any information on how portfolios should be built. By adapting the Sharpe ratio, they proposed an alternative measure called M². Their measure is expressed in basis points of outperformance, which is easier to understand for the average investor, and it adjusts for differences in volatility between the portfolio and its benchmark. However, according to Muralidhar (2000), this measure still lacks some essential qualities. More...
17/06/05
Performance
Kenneth Winston. Constructing an efficient portfolio presupposes considering both its risk and return. In order to make the process simpler, indicators summing up risk and return in one scalar have been developed and proposed to investors. These single scalar measures, which include the Sharpe ratio, the information ratio, the Treynor ratio and Jensen's alpha, serve to evaluate portfolio performance. The fund rating system proposed by Morningstar is also based on a single number to evaluate fund performance. The methodology, introduced in 1985, has since been improved. Nevertheless, the new measure still shows some weaknesses. Winston underlines the fact that single scalar measures are not sufficient to describe portfolio behaviour. More...
10/06/05
Performance
R.J. Surz. Surz examines the application of Monte Carlo Simulation (henceforth MCS) to hedge funds, by testing the hypothesis “Performance is good”. MCS is presented as an alternative to traditional performance measurement approaches. According to the author, traditional peer groups and indexes cannot be used in the hedge fund area. The test is conducted as follows: the actual performance is compared to all the possible outcomes previously evaluated (“what could have happened”). More precisely, the possible outcomes correspond to the possible portfolios that a hedge fund manager could have constituted. These portfolios are created on the basis of the investment parameters followed by the hedge fund manager, for example the investment style, the long and short positions, the fees and the leverage. The author applies the MCS by focusing on the Market Neutral strategy.
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08/06/05
Performance
J. Brunel. The increasing number of hedge funds and the growing amounts invested in this area are sources of debate on the hedge fund market's capacity to continue to generate high yields, in spite of a potential erosion of the various market opportunities. In this study, where the hedge fund universe is separated into three groups (traditional absolute return strategies, semi-directional strategies and managed futures), the author conducts a polynomial trend analysis of the alphas, on periods from December 1990 to June 2004 and from January 1993 to July 2003. He recognizes the possible limitations of his study due to the fact that the alpha is calculated in a “unidimensional” way, by subtracting the return of an “asset class benchmark”. More...
13/05/05
Performance
V. Karavas, H. Kazemi, G. Martin and T. Schneeweis. In this paper, Karavas, Kazemi, Martin and Schneeweis study the impact of leverage on risk and return in the hedge fund universe. They examine 6 strategies, namely Convertible Arbitrage, Equity Hedge, Event Driven, Distressed Securities, Merger Arbitrage and Equity Market Neutral, on the basis of CISDM and TASS databases, from January 2000 to March 2003 (39 monthly observations). After dividing the sample into two equal-weighted indexes that represent respectively funds with reported leverage information and funds which do not report leverage information, the Welch t-test and the Kolmogorov-Smirnov test exhibit that for the six strategies the distributional characteristics do not differ between the two indexes. More...
06/05/05
Performance
Arturo Rodriguez Castellanos, Belén Vallejo Alonso. This article deals with the problem of fund classification. It is usual to group funds according to the asset classes in which they are invested or according to their investment style. The resulting groups serve in particular to compare fund performance and to perform a ranking of the funds. These groups are supposed to be made up of funds exhibiting similar characteristics and risk. Meanwhile, several studies have identified evidence of fund misclassifications. It appears that funds are often subjected to a level of risk that is higher than that declared by managers. This subject of misclassification is quite important as investors often rely on fund categories to select the funds in which they want to invest. They are in particular greatly influenced in their choice by the ranking of funds according to performance within the categories. More...
15/04/05
Hedge Fund Allocation
Ivilina Popova, David Morton, Elmira Popova. It is now well documented that several hedge fund strategies tend to have non-normal return distributions and exhibit significant positive or negative skewness and a high level of kurtosis. Portfolio optimization and asset allocation models based on the mean variance framework ignore this. Consequently, they are unable to provide an accurate view of how hedge funds effectively behave within a portfolio. In particular, most of the time, they suggest overoptimistic hedge fund allocations, with great mean variance characteristics, but unacceptable levels of skewness and kurtosis. In this paper, the authors provide an effective means of dealing with this problem. The general problem of maximizing an investor’s utility of wealth function over one period and a set of asset classes with known return distributions is hard to solve exactly, because it involves both non-normal distributions and a continuous range of potential returns. More...
04/04/05
Indexes
Jacobson Fund Managers. This paper examines several strategies for investing in investable hedge fund indices. The investing strategies studied involve equally weighted buy and hold portfolios, portfolios formed on the basis of cumulative returns (with the use of a simple momentum and contra/reversal models), and portfolios formed on the basis of the Rachev ratio (with the use of simple momentum and contra/reversal models). For each strategy the authors observe heterogeneity in the returns displayed by the different indices provided by FTSE, HFR, MSCI Lyxor and Standard and Poor’s, with a calculation period from January 1998 to September 2004.
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16/03/05
Asset Allocation
L. Favre, J.A. Galeano In this paper the authors analyze the impact of hedge funds on a “typical” Swiss pension fund portfolio satisfying the regulation established in the “Loi sur la prévoyance professionnelle” (LPP). As stressed by the authors, mean-variance analysis has largely been utilized in the literature to assess the diversification properties of hedge fund strategies. However, this approach relies on two assumptions that are violated in the case of hedge funds, namely, investors have quadratic utility and asset returns are normally distributed. First, investors care about higher moments, and second, hedge fund returns are skewed and leptokurtic (i.e. fat-tailed). More...
20/02/05
Asset Allocation
J.-H. Cremers, M. Kritzman, S. Page It has widely been shown in the literature that hedge fund strategies generate non-normal returns. The authors investigate the extent to which the efficacy of mean-variance optimization is compromised in the presence of significantly negative skewness and positive kurtosis. They thus construct portfolios focusing on specific strategies (i.e. equity hedge, convertible arbitrage, event driven and merger arbitrage) as well as diversified portfolios (i.e. across all of the aforementioned strategies), with funds taken from the CISDM database from January 1994 through December 2003. They then compare the results obtained through mean-variance and full-scale optimization, for investors with, alternatively, log wealth utility functions and bilinear or S-shaped value functions. More...
20/02/05
Alternative Investments
A. Passow Hedge fund strategies may be classified into two broad categories: low volatility and high volatility strategies. Obviously, when using the traditional mean-variance optimization procedure, strategies falling into the first category receive the largest allocation. However, this does not account for the interaction between the first four order moments of the return distribution (i.e. mean, standard deviation, skewness and kurtosis). To address this issue the authors suggest modeling higher order moments while applying the Johnson cumulated densities, and propose a new framework based on the Johnson-Omega. More...
20/02/05
Alternative Investments
L. Favre, J.A. Galeano In this paper, the authors build on Huisman, Koedjik, and Pownall’s (1999) work on asset allocation in a VaR framework, and propose using the Cornish Fisher (1937) expansion to take account of the third and fourth order moments of the return distribution (i.e. skewness and kurtosis). The rationale behind this approach is that risk is underestimated if the portfolio has negative skewness and/or positive excess kurtosis. As stressed by the authors, as long as the underlying assets present normal return distributions, portfolios constructed in a mean-variance and mean-VaR framework are identical (see Arzac and Bawa (1977)). More...
20/02/05
Asset Allocation
S. Chung, M. Rosenberg, J.F. Tomeo The efficiency of the asset allocation process strongly relies on the stability of the parameters. It is thus extremely important, at a preliminary stage, to identify groups of assets presenting similar characteristics and behaviours through time. Due to the considerable diversity of investment styles in the alternative arena, and to the lack of consensus regarding the definition of hedge fund strategies, this task is particularly challenging. More...
20/02/05
Alternative Investments
P.A. Barès, R. Gibson and S. Gyger There is ample evidence in the literature that the attrition rate for hedge funds is significantly higher than that observed for mutual funds. Measuring the consequences of the survival uncertainty of hedge funds is thus an acute issue when it comes to measuring hedge fund performance or constructing portfolios of hedge funds. To investigate the latter issue, the authors suggest using a framework that allows the risks associated with hedge fund’s survival uncertainty to be accounted for. In an initial step, the authors calculate the survival probabilities associated with the different funds contained in the sample. To this end, they use three determinants, namely, the size of the assets under management, the style consistency of the manager, More...
17/02/05
Alternative Investments
F.S. Lhabitant, M. Learned.. Studies on alternative diversification have long focused on the impact of the introduction of hedge fund strategies into traditional portfolios. The originality of this paper is to tackle the diversification issue from a different perspective. What is the behavior in terms of risk and return of a focused fund of hedge funds when the number of its constituents increases? In an attempt to avoid over-exposure to one specific fund, fund of hedge fund managers invest in several funds. They thus diversify specific risks. Unfortunately this does not come as a free lunch. Increasing the number of funds lead to a dilution of the contribution of each fund to the return and risk profile of the fund of hedge funds. As a result, fund of hedge fund managers have to determine a reasonable trade-off between under- and over-diversification. More...
16/02/05
Alternative Investments
R.J. Davies, H.M. Kat, S. Lu The authors introduce a Polynomial Goal Programming (PGP) optimisation model to account for third and fourth order moments of the return distribution (i.e. skewness and kurtosis) in portfolio construction. This approach incorporates investor preferences for high moments and is aimed to construct portfolios presenting an optimal balance between multiple conflicting objectives such as the maximization of expected returns and/or skewness and the minimization of volatility and/or kurtosis. Solving the multiple objective PGP involves a two step procedure: 1/ expected return, skewness and kurtosis are each obtained within a unit variance two space framework, 2/ a minimum value of the multiple objective function is calculated with these values for a given set of investor preferences within the four-moment framework. More...
16/02/05
Alternative Investments
D. Morton, E. Popova, I. Popova. To tackle the problems raised by hedge funds’ non-normal returns, the authors propose the use of a general and flexible framework based on a family of utility functions, which incorporate benchmark returns, to improve the asset allocation process. To this end, they utilize recent advances in stochastic programming and modelling to make better use of information embedded in hedge fund return distributions (e.g. skewness, kurtosis). The authors define the return dimension as the probability of achieving a specified benchmark, and define the risk dimension as the expected shortfall. The resulting utility function thus rewards out-performance over the benchmark and penalizes downside deviations from the benchmark. More...
15/02/05
Alternative Investments
R. McFall Lamm, Jr. The mean/variance approach, introduced in Markowitz (1952), laid the basis of Modern Portfolio Theory. This approach is now challenged and many studies have highlighted its limits, especially when the returns of the underlying assets are skewed and fat-tailed. As stressed by the author, it has been shown widely in the literature that the hedge fund return distribution presents outliers. He thus suggests comparing several optimization techniques to assess the extent to which incorporation of asymmetry produces significantly different portfolios. The author first uses EACM, HFR and CSFB/Tremont indices from January 1990 through December 2002, to assess the extent to which the return distribution of hedge fund strategies departs from normality. More...
15/02/05
Asset Allocation
A. Conner. It has been widely argued that hedge fund strategy returns present a significant degree of auto-correlation, leading to biased estimators of risk and risk-adjusted performance indicators. In this article, the authors analyse the impact of “stale prices” on the asset allocation process. In an initial step, the author proposes to unsmooth the observed series of returns to mitigate the stale prices bias. To do so, he proposes a general form of the smoothed process consisting of a weighted sum of current and lagged returns. The relevant number of lag periods is determined by the degree of significance of autocorrelation coefficients. Once the number of lag periods has been determined and the corresponding weights calculated, the author applies an adjustment factor to obtain the volatility and correlation coefficients of the unsmoothed series. More...
15/02/05
Asset Allocation
K. Terhaar, R. Staub, B. Singer Institutional investors are becoming increasingly interested in the appealing diversification properties of alternative investments. However, in order to benefit fully from their diversification potential, they must first answer two questions: 1/ which alternative investments should be included? and 2/ what should the alternative investment allocation be in traditional investors’ portfolios. As stressed by the authors, when using traditional mean-variance optimization with historical returns and covariance matrices, due to their (high) return, (low) volatility and (low) correlation characteristics, all the capital is allocated to alternative investments. Such a scenario is however unthinkable. To obtain an allocation that is more consistent with traditional investors’ preferences, More...
15/02/05
Asset Allocation
T. Schneeweis, V. Karavas, G. Georgiev. In this article, the authors analyze the impact of the introduction of alternative investments (real estate, commodity, hedge funds, CTA, etc.) on a traditional portfolio, in a mean-variance framework. In their optimization procedure, the authors use two sets of returns, namely historical returns and expected returns. The latter are calculated assuming: 1/ a simple linear relationship between returns, 2/ that historical variance is a good proxy for future risk, and 3/ the Sharpe ratio is arbitrarily set to 0.66. The authors use EACM hedge fund indices from 1990 through 2001. In the first analysis, the authors compute efficient frontiers for portfolios exclusively made up of alternative assets. In the second analysis, the authors mix traditional and alternative assets, More...
15/02/05
Asset Allocation
C. De Souza, S. Gokcan. Despite the rapid growth of assets under management in the alternative industry, the authors observe that very little has been published to extract value from hedge fund strategies at a sophisticated level. In this article the authors present a systematic investment methodology for allocating capital among hedge fund strategies. The authors first analyse the statistical properties of hedge fund strategies. To this end, they use the HFR indices from January 1990 through October 2002. They utilize a bootstrap method to improve the accuracy of the results of the Jarque-Bera statistic, and use a variance ratio test for serial correlation (see Lo and McKinlay (1988)). Most strategies turn out to depart significantly from normality. More...
15/02/05
Performance
K. A. Clark and K. Winkelmann. Performance can be viewed as the combination of the exposure to market moves (passive risk) and manager skill (active risk). The information ratio is the ratio of the average alpha to the residual risk, where residual risk is the standard deviation of alpha over time. The formulation of alpha as the product of the information ratio and the residual risk permits two sources of alpha to be highlighted: the manager’s investment skill (information ratio) and the exposure to active risk (residual risk). The authors use data from the CISDM hedge fund index to develop a risk budgeting process. Six strategies are studied, namely market neutral, fixed income arbitrage, event driven, equity long/short and tactical trading, over the period from January 1994 to November 2003. More...
11/02/05
Risk Measurement
Hilary F. Till. This paper provides a risk framework for fiduciaries by 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. More...
31/01/05
Performance
J. Loeys and L. Fransolet. Market opportunities can be exploited in two ways: exploiting structurally high risk premia and exploiting temporary market opportunities. In both cases, several high-return opportunities are identified by the authors. Concerning the structural exploitation of high risk premia, there are term premia at the short end of the interest rate curve, credit spreads at the short end of the curve, the mispricing of BBs, the forward bias in foreign exchange, equity anomalies and mispricings in options. More...
28/01/05
Performance
Gordon H. Dash and Nina Kajiji. Two leading approaches can be followed to predict returns: a return-level approach and a classification-based approach. The first method involves predicting a future return level, while the second method involves predicting the direction of the returns. The results of three different test algorithms are presented: the Kajiji radial basis function (henceforth RBF) algorithm, the SPPS RBF algorithm and the Statsoft RBF algorithm. The study focuses on the monthly returns of 13 hedge fund indexes provided by CSFB/Tremont, covering the period from January 1994 to December 2002. The Dedicated Short Bias index exhibits the highest volatility. The Equity Market Neutral index displays the lowest volatility. A Shapiro-Wilk test shows that returns are not normally distributed.
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04/01/05
Performance
Y. F. Yao, B. Clifford and R. Berens. This study is dedicated to the leading hedge fund strategy in terms of assets under management, namely long/short equity. Depending on the number of sectors in which long/short equity hedge fund managers invest, they are classified as specialists or generalists. A sector specialist invests in one specific sector, while a sector generalist invests in several sectors. The authors propose to compare generalists and specialists according to their diversification benefits and their risk-adjusted performance. They underline the need to use distinct benchmarks, because the investment universe differs: a broad market index is required for generalists (in the paper the HFR Equity Hedge Fund Index is used, and their long-only counterpart is the Russell 3000 Index), in contrast with specialists, which have to be associated with the appropriate sector market indices... More...
27/12/04
Performance
Alexander M. Ineichen. Returns that are not normally distributed are asymmetric. According to Ineichen, when the investment process is not driven by market benchmark but by P&L, risk is defined in absolute terms, and investors prefer a right-skewed distribution over a normal distribution. Hedge fund managers that are sector specialists manage a special type of long/short equity fund and typically have a long bias, which means that there is a high correlation to the sector in which they invest. The absolute drawdowns induced by high correlations defeat the notion of capital preservation. Consequently, the goal is to maximise the P in P&L, and to avoid the L. Three sectors are studied, More...
07/12/04
Performance
Stanley M. Atkinson, Ray R. Sturm. This article deals with the subject of the ability to identify funds that will have superior performance in the future, and performance that will persist. The authors have chosen to perform their test on the 25 stock mutual funds selected by USA Today and designated by the paper as its “all-stars”. These funds are supposed to be consistent long-term performers. The aim of the present study is to investigate whether these funds reported to be better than their peer group are in fact worth investing in. The authors first give an overview of the previous studies that have concerned fund performance and persistence. The results are controversial. Some of them identified a certain amount of performance persistence, while others did not. More...
29/11/04
Indexes
G. Bousbib, P. Ewing, E. Zask.The hedge fund industry is reputed to offer absolute returns. The notion of absolute returns excludes their comparison to the performance of a benchmark. Nevertheless, according to the authors, the use of a benchmark becomes increasingly important in bearish market conditions. In bullish markets, when the returns are high, investors and managers are less prone to identifying the source of the performance, i.e the alpha or the beta. When poor returns are generated, the comparison between the performance displayed by actively managed hedge funds and the performance of passive indices is crucial. More...
17/11/04
Risk
Jean-François Bacmann, Gregor Gawron. Using Extreme Value Theory, Bacmann and Gawron show that there is not extreme dependence between fund of hedge funds and bonds, but there is some extreme dependence between funds of hedge funds and equities. More...
15/11/04
Performance
Michele Gambera. In this article, Gambera sums up the criticism of the Sharpe ratio and reviews the alternative propositions to this performance measure. He first recalls that the Sharpe ratio is drawn from the mean variance analysis model developed by Markowitz. Consequently, it is subject to criticism in relation to the mean variance model hypothesis. The Sharpe ratio of a portfolio is defined as the expected excess return of this portfolio compared to a risk free asset, divided by the total risk of the portfolio, measured by the standard deviation. Considering the mean-variance plane and plotting the portfolio and the risk free asset on this plane, the Sharpe ratio is the slope of the line that links the portfolio and the risk free asset. More...
10/11/04
Performance
Greg N. Gregoriou. It is now well-known that the Sharpe ratio, which is considered a traditional performance measure, introduces a bias when the distribution of returns is not normal, because the use of standard deviation as a measure of the risk exposure is inadapted. The tail risk is underestimated when the variance is used, and consequently the Sharpe ratio overestimates performance. To alleviate these difficulties in considering risk exposure, the value-at-risk measure (henceforth VaR) has received increasing acceptance. However, the normal VaR, considering only the mean and the standard deviation, is not a relevant alternative. More...
02/11/04
Performance
Bernd Scherer. The determination of confidence intervals is a non-negligible step in a performance analysis problem, in addition to the calculation of risk-adjusted ratios. However, confidence bands are difficult to determine in the presence of arbitrary risk-adjusted returns, sample sizes and distribution. Scherer uses a bootstrapping method as a generalized method to obtain a bootstrap sampling distribution. It is on the basis of this resampled distribution that the normality of small samples will be judged. From January 1990 to April 2003, the Sharpe and Sortino ratios of the HFR Fund of Funds index are calculated.
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31/10/04
Performance
Mathew R. Morey. Several studies have underlined the fact that U.S. investors tend to rely greatly on Morningstar star ratings to select their funds. For example, Del Guercio and Tkac (2002) found that the Morningstar star rating had a significant effect on fund flows and that a fund’s initial 5-star rating produced an abnormal inflow of 53% above the normal expected flow for about six months, while rating downgrades caused significant outflows beyond what would normally be expected. In the present article, Morey investigates how a fund's performance evolves just after it receives a 5-star rating for the first time. This study is related to the issue of performance persistence, but here the author uses a different approach from the one commonly adopted in the literature. More...
29/10/04
Performance
Kevin C.H. Chiang, Kirill Kozhevnikov, Craig H. Wisen. This article investigates the differences between the rankings of funds produced by Morningstar’s risk-adjusted rating (RAR), and those generated by other risk-adjusted performance measures. The RAR appears to be the most widely used measure in the industry. Del Guercio and Tkac (2001) showed that Morningstar’ ratings have a considerable influence on U.S. investors’ behaviour towards fund selection. Meanwhile, Sharpe (1998) demonstrated that selecting funds within peer groups constructed by using the Morningstar rating as the only criterion was not efficient for building a multi-fund portfolio. More...
22/10/04
Performance
Lars Tyge Nielsen, Maria Vassalou. In this paper, Nielsen and Vassalou propose an extension to the Sharpe ratio and Jensen’s alpha to suit continuous time investment. They first recall some basic elements of continuous time finance models, defining the instantaneous expected rate of return and volatility of a fund. They then derive the instantaneous Sharpe ratio in the same way as the discrete Sharpe ratio, using instantaneous rates of return instead of rates of return over finite time intervals. They assume that investors build their portfolio by choosing one fund and allocating their wealth between this fund and the riskless asset, in order to maximize the expected utility of their final wealth. More...
15/10/04
Performance
H. Kazemi and T. Schneeweis.Stale prices occur when managers, because they trade in illiquid securities, have the ability to smooth prices. The consequence is underestimated volatility, resulting in overestimated risk-adjusted returns. In this study, stale prices are revisited from the following angle: Kazemi and Schneeweis do not introduce a new methodology (they apply the methodology used by Asness, Krail and Liew (2001)*) based on the Credit Suisse Tremont hedge fund indices, but they conduct their tests for two periods. The first period is from January 1994 to March 2003, excluding fall 1998, and the second is from January 1999 to March 2003. More...
14/10/04
Performance
R. Kosowski, N.Y. Naik and M. Teo. This paper examines hedge fund returns from the angle of a bootstrap method, in order to test whether they can be explained by luck alone. A short performance persistence analysis, focused on alpha, is also conducted. The database contains datasets provided by CISDM, HFR, MSCI and TASS. It gives a more complete picture of the hedge fund universe. The period is from January 1991 to December 2002. More...
07/10/04
Indexes
Kenneth S. Reinker, Edward Tower. There is a controversial argument between those who believe that index funds tend to deliver better returns than managed funds, and those who assert the opposite. In this article, Reinker and Tower investigate the relative performance of index funds versus managed funds. Their study is based on Vanguard’s funds, because it is the only broad family of low-cost funds. They first investigated whether it would have been better to invest into Vanguard’s broadest U.S index fund, into a portfolio of Vanguard’s index funds, weighted by the size of each fund, or into a portfolio of Vanguard’s managed funds, also weighted by the size of each fund. More...
05/10/04
Indexes
Bala Arshanapalli, Lorne N. Switzer, Loretta T.S. Hung. Tactical asset allocation was the subject of numerous studies during the nineties and interest in this technique has been reinforced in recent years by evidence on the predictability of stock returns using various economic and financial variables. Previous research considered asset allocation between stocks, bonds and Treasury bills. In the present article, Arshanapalli, Switzer and Hung study a two-way asset mix between the S&P 500 index and the MSCI EAFE index. According to the authors, this is the first article on the subject of tactical asset allocation to deal with such a combination. More...
24/09/04
Performance
Jose Menchero. Performance attribution serves to evaluate portfolio performance relative to a benchmark. The performance is decomposed into several effects. One of the most widely used models, Brinson, Hood and Beebower's, involves decomposing the performance into sector selection, stock selection and a term for the interaction between the sector and selection effects. A more general model has also been derived to suit multiple currencies. More often than not the performance is described for one time period. This is suitable only for very short time periods. More...
23/09/04
Indexes
Ananth Madhavan. In this article, Madhavan considers the specific problem of funds holding foreign securities traded on stock exchanges that close before the U.S. market. The usual rule is to use the closing prices to compute the Net Asset Value of the fund, but this may produce stale fund prices, as prices of foreign assets are obtained several hours before those of the US assets. Madhavan explains that stale prices may benefit short-term investors practising market timing, but harm the performance of long-term shareholders. To solve this problem, mutual fund companies are using fair value models to adjust the closing prices of foreign securities. These models enable information that is available after the close of the foreign market to be taken into account. More...
02/08/04
Performance
Greg N. Gregoriou. Survivorship bias is one of the potential biases that affect databases. Survivorship bias occurs if the database only contains information on 'surviving' funds. Since this bias has a positive impact on returns, it is interesting to analyse the mortality of funds as part of performance measurement. In this paper, Gregoriou conducts a survival analysis that focuses on funds of hedge funds (henceforth FoHFs). The data used, provided by ZCM, covers the period from January 1990 to December 2001. It contains 344 live and 191 defunct funds. More...
23/07/04
Indexes
Stephen Campisi. The choice of benchmark is essential in portfolio performance measurement, in order to properly evaluate the results of portfolio managers. This benchmark must be suited to the strategy followed by the portfolio. In this article, the author first identifies the problems caused by the use of broad benchmarks. More specifically considering bond management, he then describes how to construct and manage custom benchmarks.
The author first enumerates the desirable properties of a benchmark. A benchmark should have the same systematic risk as the portfolio strategy, the same style characteristics and it should be highly correlated with the portfolio. Most of the time, the benchmarks used to evaluate the performance of portfolios are not representative of the portfolios. More...
16/07/04
Indexes
Lars Jaeger. This paper gives a succinct overview of hedge fund indices. According to the author, the heterogeneity of the indices is due to the heterogeneity of the construction criteria, such as weighting schemes or fund selection. He illustrates this heterogeneity by the fact that in 2003 the HFR Composite index displayed a return of 19.6%, which differed widely from the 11% displayed by the S&P Hedge Fund Index, even though those two indices are supposed to represent the same universe. The shortcomings implied by averaging single hedge funds are underlined. Indeed, databases suffer from numerous biases, such as survivorship bias or selection bias. Moreover, the attributes of a good index are difficult to attain.
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13/07/04
Indexes
Lars Jaeger. This paper gives a succinct overview of hedge fund indices. According to the author, the heterogeneity of the indices is due to the heterogeneity of the construction criteria, such as weighting schemes or fund selection. He illustrates this heterogeneity by the fact that in 2003 the HFR Composite index displayed a return of 19.6%, which differed widely from the 11% displayed by the S&P Hedge Fund Index, even though those two indices are supposed to represent the same universe.
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13/07/04
Indexes
Oliver Zhen Li. The weak form of the efficient market hypothesis has been called into question by the results of numerous academic studies showing that certain trading strategies, such as momentum and/or contrarian strategies, exhibit excess returns. These tendencies are related to positive or negative autocorrelation observed in time series returns. Most of these studies assume stock returns are linear except Niederhoffer and Osborne (1966) and McQueen and Thorley (1991). In these two studies, the directional movement of stock returns is examined using the finite state Markov chain approach. And the non-linearity is taken into account by allowing the transition probability to vary depending on a given sequence of prior states. More...
12/07/04
Indexes
Lian Peng. Indices have two main uses in asset management. They serve to analyze the risk and returns of asset classes and to measure portfolio performance. The development of an index involves two aspects. The first aspect concerns the choice of the index that will be suited to the needs and the second aspect relates to the estimation of the index chosen. Depending on market conditions, the difficulties encountered will not be the same. The construction of an index is easier in liquid markets, where individual asset values are consistently observed, than in real estate and venture capital markets, where observations are sparse. Peng underlined the fact that different indices are required depending on their dedicated use. More...
05/07/04
Performance
C. De Souza and Suleyman Gokcan. The selection of individual managers is a key step in hedge fund investing. Indeed the risk and return dispersion in the same strategy highlights the heterogeneity among managers, to differing degrees among strategies. Consequently, strategy factor risk is not a sufficient basis to construct a portfolio of hedge funds. Moreover, a simple diversification of fund-specific risk via an increase in the number of funds can engender an increase in the exposure to market risk factors. More...
05/07/04
Risk
Dario Brandolini, Massimiliano Pallotta, Raffaele Zenti. Risk management is a subject that is tending to be given more and more attention. Various risk indicators can be derived using an estimation of the probability distribution of portfolio returns. Risk indicators can then be used in a risk policy, in order to manage portfolios while keeping risk under control. Numerous articles are dedicated to the subject of risk indicator estimation, while little attention is paid to risk policies. In this article the authors do not consider estimation techniques, but focus instead on risk policies. They investigate whether the use of risk indicators in a risk policy can improve the risk-adjusted relative performance of an actively managed portfolio of European stocks. More...
29/06/04
Performance
Greg N. Gregoriou and Jean-Pierre Gueyie. Applied to the hedge fund universe, traditional performance measures that assume a mean-variance framework suffer from some limitations, mainly due to the non-normality of returns. The authors propose an improvement to the original Sharpe ratio through the use of the modified Value-at-Risk (MVaR). The new performance measure is named the Modified Sharpe ratio. In the equation of the modified Sharpe ratio, the modified VaR is introduced instead of the standard deviation. This is justified by the fact that the MVaR takes into account skewness and kurtosis. More...
11/06/04
Performance
Hendrick Scholtz, Marco. The Sharpe ratio has been widely used for about 40 years to evaluate portfolio and fund performance. In this article, Scholtz and Wilkens wonder whether this measure remains relevant in abnormal periods, when funds’ average excess returns are negative (bear markets), and particularly whether it allows to funds to be ranked reasonably in those periods. The main contribution of this article is to highlight the fact that the Sharpe ratio is determined not only by the manager’s skill, but also by the market climate. More...
19/05/04
Performance
Hung-Gay Fung, Xiaoqing Eleanor Xu and Jot Yau. The calculation of risk-adjusted excess returns can be impacted by several biases. Firstly, the performance of a group of hedge funds has to be compared to an index related to the same style. That is why this paper focuses on the equity-based style. Secondly, the presence of stale prices has to be taken into consideration. Therefore Dimson’s approach (1979) is used. Thirdly, skewness and kurtosis have to be taken into account. This is done by the authors through a modified single-factor CAPM. The hedge fund database, provided by CISDM, covers the period from 1994 to 2000. More...
07/05/04
Indexes
Gus Sauter. Since the creation of the first market index, the Dow Jones Industrial Average, ever more specialised indexes have been developed to answer the needs of portfolio managers who require suitable benchmarks to evaluate the performance of their portfolios. Portfolio managers are more often than not specialised in a specific style or asset category. However, it appears that the indexes available do not constitute good benchmarks for portfolio managers. The various indexes that are supposed to represent the same style actually have low correlation. More...
29/04/04
Indexes
Gary L. Gastineau. It appears that indexed exchange-traded funds (ETF) exhibit lower performance levels than traditional indexed mutual funds. In this article, Gastineau proposes some explanations for this phenomenon. First, he recalls that conventional indexed mutual funds and benchmark index ETFs are in fact competing products. He notes that the comparisons between these two products have tended to focus on expense ratios and on the relatively greater tax-efficiency of the ETFs, but have ignored the apparently higher operating efficiency of conventional index funds.
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26/04/04
Indexes
Majed R. Muhtaseb. This article deals with investable hedge fund indices. Theoretical shortcomings and practical challenges are examined. Concerning theoretical shortcomings, the author weighs up whether hedge funds constitute an asset class or not. As far as the practical challenges are concerned, the viability of the construction of an investable benchmark is studied. An initial approach is that, to be considered an asset class, hedge funds have to respect several criteria. For example, "prices and composition information are readily and constantly available."
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26/04/04
Indexes
Majed R. Muhtaseb. This article deals with investable hedge fund indices. Theoretical shortcomings and practical challenges are examined. Concerning theoretical shortcomings, the author weighs up whether hedge funds constitute an asset class or not. As far as the practical challenges are concerned, the viability of the construction of an investable benchmark is studied.
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26/04/04
Asset Allocation
Mark Lundin. In this article, the author first recalls the principles of asset allocation. Asset allocation involves choosing the proportion of the portfolio to invest in each asset class. Large asset classes include stocks, bonds, real estate and cash. These asset classes can be further divided into narrower sub-classes. Diversification among asset classes enables a better compromise between portfolio risk and return to be obtained. Asset allocation consists of strategic asset allocation, which concerns long-term allocation, and tactical allocation, which consists of modifying the portfolio's asset class weights on a short-term basis. More...
23/04/04
Indexes
William Fung and David A. Hsieh. The weighting scheme in a hedge fund index is problematical. In the traditional universe, indexes are mainly equally-weighted or value-weighted. However, according to Fung and Hsieh, these weighting schemes are not suitable in the case of hedge funds. In order to alleviate these difficulties, the authors propose a new method, where return-based and asset-based style factors are introduced. Return-based style factors are the common components of hedge fund returns obtained through a principal components procedure. More...
21/04/04
Indexes
Dr. P. Meier, Dr. A. Ruckstuhl, O. Kündig and S. Lodeiro. This study focuses on 4 index providers in the alternative universe: Tuna, HFR, Altvest and VAN. For each of these providers, both hedge fund indices and fund of hedge fund indices are examined. This approach permits the statistical properties obtained through the two index construction methodologies to be compared. According to the authors, an index can have three distinct purposes: it can have an informational function by representing the market; More...
09/04/04
Indexes
M. Anson. Since institutional investors use relative returns in their investment process, there is a requirement for index construction in the hedge fund industry, like in the traditional universe.
However, the construction of hedge fund indexes is complex. This is due to the uncertainty on the size of the hedge fund universe, the biases that affect the data, the strategy classification of the hedge funds and the need for investable indexes. The uncertainty on the size of the hedge fund universe is related to the fact that hedge funds are not required to report their performance to the index providers. More...
02/04/04
Indexes
A. Kohler. This paper highlights the difficulty of implementing an index-based approach in the hedge fund industry. A distinction is made between the theoretical shortcomings and the practical challenges. Due to the specific characteristics of the hedge fund industry, hedge fund indexing is not a simple application of the methodology used in the traditional universe. Considering the theoretical shortcomings, the weighted-average return obtained through an index is valid only if assets are priced by market participants. This is not the case for hedge funds, More...
01/04/04
Performance
K. Chen and A. Passow. Chen and Passow propose a multi-factor model to select hedged equity funds (long-short equity, dedicated short bias and equity market neutral). It mainly consists of eliminating the funds that exhibit large exposure to one or more risk factors. The aim is to obtain higher risk-adjusted return than the whole long-short hedge fund universe. The authors bring together skilled managers and non-skilled managers. Skilled managers are those who selects stocks on the basis of internal information, while the others select stocks on the basis of public information. In other words, skilled manager funds are intended to have no or weak exposure to the factors used by non-skilled managers.
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26/03/04
Indexes
Alex Frino, David R. Gallagher, Albert S. Neubert, Teddy N. Oetmo. An index fund is supposed to replicate the return and the risk of an index chosen as benchmark. However, its pre-cost performance is never equal to the performance of the index. This is because the index is the result of a theoretical calculation, while it is necessary to perform stock transactions whenever the index is modified in order to keep the replicating fund in line with its benchmark. Due to market frictions, this results in a tracking error in index fund performance. This tracking error is made up of two components: an endogenous component and an exogenous component. More...
19/03/04
Performance
Paul D. Kaplan and James A. Knowles. Kappa, introduced by Kaplan and Knowles, is presented as a generalized downside risk-adjusted performance measure. "Generalized" means that this indicator can become any risk-adjusted return measure, through a single parameter. The authors illustrate that Kappa is a generalized performance measure by an application on the Sortino ratio and Omega. Kappa can be calculated in two ways: it can use discrete return data or a parameter-based calculation. More...
10/03/04
Performance
R. McFall Lamm, Jr. While the issue of the optimal hedge fund portfolio has been mainly examined in terms of allocation to stocks, bonds and hedge funds, this paper analyses the optimal allocation to the different hedge fund strategies. The author highlights the importance of the asymmetric returns of hedge funds in the application of portfolio optimization techniques.
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26/02/04
Asset Allocation
Kevin C.H. Chiang. This article compares the asset allocation revision of aggressive and conservative portfolios. The portfolios are assumed to be made up of stocks, bonds and cash, with a greater proportion of bonds relative to stocks for the conservative ones. One of the most popular models used to derive portfolio asset allocation is Markowitz’s mean variance model, which is based on a one-period horizon. According to this model, the proportion allocated to common stocks is linearly related to risk aversion. As a result, in case of revisions concerning the returns distribution, a portfolio manager should rebalance common stocks in the same proportion whether for an aggressive or a conservative portfolio. More...
20/02/04
Risk
R.T.Rockafellar, S.Uryasev. In this paper, the authors develop their method for measuring the probability of extreme asset loss: this method is the Conditional Value-at-Risk. They show the advantages of using Conditional Value-at-Risk (CVaR) for extreme loss measurement, generalize it for discontinuous distributions and use it to optimize portfolios in order to reduce extreme negative risks. Value-at-Risk is a popular measure of risk. VaR measures the loss that can occur with a certain probability over a certain period of time (normally 10 days, 1 month or 1 year). But VaR suffers from four drawbacks: More...
19/02/04
Performance
N. M. Boyson. An increasing amount of literature is being published on the question of the persistence of hedge fund performance, with a broad variety of test methods employed. The author deals with this subject through a new approach, introducing the notion of manager tenure. Moreover, style factors are added to the model. The data, provided by TASS, covers the period from January 1994 to December 2000. More...
11/02/04
Performance
D. Capocci, A. Corhay and G. Hübner. Using a ten-factor combined model, Capocci, Corhay and Hübner analyse the performance of hedge funds over two successive sub-periods that correspond to bullish and bearish periods. The analysis is also carried out at a strategy level, and the contribution of each factor is studied. The persistence is tested in the final part of the paper. The advantage of this approach is to compare the behavior of hedge fund performance in two opposing stock market situations. More...
09/02/04
Performance
R.J. Davies, H.M. Kat, and S. Lu. Single strategy funds of hedge funds, by investing in funds that pursue a specific strategy, suffer from under-diversification in the context of a mean-variance analysis. The aim of the paper is to demonstrate that conclusions differ in a four-moment framework. Following the TASS classification, a single strategy fund of hedge funds can focus on one of the following strategies: long/short equity, equity market neutral, convertible arbitrage, distressed securities, merger arbitrage, global macro, emerging markets or dedicated short bias. More...
30/01/04
Performance
J. A. Adkisson, Ron D. Fraser. This article deals with the problem of the age bias in the Morningstar ratings. It is related to Adkisson and Fraser (2003) and completes it by describing the statistical tests performed by the authors to test the hypotheses described in their previous article. This problem of age bias was already investigated by Blume (1998), who found that older funds were less often rated at the top, than younger ones, and also by Morey (2002), who found opposing results and related this finding to Morningstar’s return weighting system. More...
30/01/04
Performance
L. Swinkels, P.J. van der Sluis and M. Verbeek. The return of a mutual fund can basically be divided into two main parts: the alpha, which is generated by the management’s selectivity skill, and the beta, which is related to the exposure to the stock market. The fund can decide to play on the market exposure depending on its market direction forecasts: this is market timing behavior. On the basis of a more detailed view of the market exposure, the authors develop an extended model to decompose mutual fund returns. They add three non-skill components to the selectivity and market timing. More...
28/01/04
Performance
N. M. Boyson. The aim of the paper is to analyse and explain the relationship between hedge fund manager age and risk-taking behaviour, and the impact of this relationship on the hedge fund returns. The risk-taking behaviour is studied in the light of agency costs and career concerns.
In the hedge fund industry, agency costs for hedge fund managers are specific in that they are lower relative to those of other money managers.
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16/01/04
Asset Allocation
Rob Bauer, Jeroen Derwall, Roderick Molenaar. Previous studies have identified differences in returns between stocks that belong to different styles. A size effect has been observed in the United States by Banz (1981), while Fama and French (1992, 1998) and Lakonishok, Schleifer and Vishny (1994) have described a value effect: there is a negative relationship between a firm’s market capitalization and its stock performance; value stocks provide higher average returns than growth stocks. However, the performance of the different styles appears to be subject to cycles. More...
19/12/03
Performance
Andrew Kophamel. A lot of research has been conducted in recent years on the two subjects of performance attribution and risk-adjusted performance measures, but without attempting to link the two. This is the specific problem that Kophamel considers in this article. The author begins with a review of the literature on performance attribution and risk-adjusted performance measures. More...
17/12/03
Performance
Milind Sharma. This study introduces an innovative risk-adjusted performance measure that is especially designed to be applied to hedge funds. The new measure is called Alternative Investments Risk Adjusted Performance (AIRAP). The author justifies the proposition of a new risk-adjusted performance by the fact that the specific characteristics of hedge funds cause the current performance measures to be inappropriate.
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12/12/03
Performance
Martin H. Herzberg and Haim A. Mozes. This study deals with the persistence of the success of hedge fund strategies over time and the use of quantitative techniques to identify the best managers on the basis of past performance.The first step involves measuring the persistence of basic fund attributes. After that, the authors focus on four parameters that are liable to have an impact on the persistence of hedge fund performance: More...
09/12/03
Performance
Bigir Orn Arnarson, Steingrimur Karason, Haraldur Oskar Haraldsson, Hrafnkell Karason. The area of return attribution over multiple periods has been the subject of several developments in recent years. In this article, the authors propose a new contribution to this field with a method that tends to be more general and straightforward than the ones derived previously.
The authors first describe an absolute attribution method. This method accords with that of Frongello (2002), but was derived independently. More...
05/12/03
Performance
N. Posthuma and P. J. van der Sluis. The authors concentrate on the backfill bias and its implications for hedge fund returns. This bias is due to the backfilling performed by data providers for hedge funds that decide to report only when they obtain good returns. It generally leads to overestimated returns. The authors highlight the fact that after the correction of the backfill bias biases can remain because of lockup periods and fund liquidation. More...
21/11/03
Performance
L. Favre and A. Ranaldo.
The authors deal with the traditional CAPM, and its possible extensions, from an interesting point of view, that of coskewness and cokurtosis. Coskewness and cokurtosis are the skewness and kurtosis of a given asset analysed with the skewness and kurtosis of the reference market. For example, hedge funds with a significant level of coskewness will increase or decrease market skewness if added to the market portfolio. More...
14/11/03
Performance
R. M. Ennis and M. D. Sebastian. The authors firstly debate the representativeness of indexes in the hedge fund industry. They argue that "after-the-fact" indexes, i.e. indexes constructed from marketed databases, display overstated returns. Funds of Funds, which display an "actual" measure (as opposed to "after-the-fact" indexes) of hedge fund performance, are more representative. More...
04/11/03
Performance
J. A. Adkisson, Ron D. Fraser. The Morningstar ratings system appears to be a convenient way for investors to make their choice among all the mutual funds available. It is true that absolute return is not a sufficient criterion, as it is also necessary consider risk. The rating system developed by Morningstar in the middle of the eighties enables the fund characteristics, including the risk parameter, to be summarised in a way that is easy to understand for basic investors. The Morningstar rating is also a useful tool for professional investors, as it gives them a risk-adjusted measure of the fund returns which takes fund expenses into account. More...
24/10/03
Performance
Gaurav S. Amin and Harry M. Kat. This study examines the appropriateness of including hedge funds in a portfolio of stocks and bonds, on the basis of a mean-variance analysis and a mean-variance-skewness analysis. A mean-variance-skewness analysis allows the specific features of the return distribution of the hedge funds to be taken into account. More...
22/10/03
Performance
C. Bang Christiansen, P. Brink Madsen, M. Christensen. The authors use Principal Component Analysis (PCA) in order to identify relevant groups of hedge fund strategies. Because of the dynamic trading strategies of hedge funds, the authors choose a multi-factor model with buy-and-hold and option strategies. They follow Agarwal and Naik’s methodology (2000), by including Location factors (buy-and-hold strategy) and Trading Strategy factors (option-like strategies) in Sharpe’s multi-factor style model. The inclusion of the factors follows a step-wise procedure, which avoids the potential problems of multicollinearity. More...
16/10/03
Performance
V. Agarwal, N.D. Daniel, N.Y. Naik. Agarwal, Daniel and Naik examine the determinants of money-flows and performance, for individual hedge funds and funds of hedge funds, from January 1994 to December 2000. This well-documented study presents several new findings, following two different approaches.
The first approach involves investigating the possible determinants of money-flows. This approach is based on the assumption that investors recognize the importance of some factors to invest in individual hedge funds and funds of funds. The second approach involves investigating the impact of flows, size and incentives on the future performance and on the persistence in future returns. It allows the question of economies of scale to be dealt with. More...
06/10/03
Tactical Allocation
Leping Wang.
The evidence of stock return predictability described in numerous studies has led to a search for the influence of this predictability on dynamic portfolio choice, and particularly if the optimal proportion invested in risky assets differed depending on whether investors had a long or short investment horizon. This later aspect is called the horizon effect. Previous studies were concerned with the problem of hedging the portfolio by choosing its composition according to the correlation between asset returns. In this article, Wang underlines the fact that the mean reversion of the return volatility may also influence an investor’s optimal portfolio choice. More...
02/10/03
Asset Allocation
Ralitsa Petkova, Lu Zhang. Value stocks appear to have higher returns than growth stocks. The explanation for this difference has been the subject of numerous studies, using different methods of investigation, to find out whether there is a risk premium for value stocks. Some of the results are controversial. In this article Petkova and Zhang study the relative risk of value and growth stocks in relation to the economic situation. They refer to the findings of previous studies and compare them with their own results, giving the reasons for the differences. The approaches used in the different studies are of two kinds. Some rely on rational asset pricing theory, while others use arguments from behavioral finance. More...
29/09/03
Asset Allocation
Favre and Galeano. The existence of non-normality in assets may lead to the choice of different portfolios with respect to the normality assumption. The authors developed a new measure based on a Cornish-Fisher (1937) expansion where the risk is measured with standard deviation, skewness (i.e. return asymmetry) and kurtosis (i.e. fat tails). The measure, called Modified VaR, is a Value-at-Risk similar to the classical Value-at-Risk but the former will be worse for an asset with extreme negative returns. More...
16/09/03
Asset Allocation
Jurcenzko and Maillet. The authors show that the Two-moments CAPM can be extended to a Four-Moment CAPM where not only mean and variance are considered, but skewness and kurtosis. They derive a unified theory in a Four-Moment Capital Asset Pricing Model framework where variance, skewness and kurtosis receive a risk premium. More...
16/09/03
Asset Allocation
H. Kazemi, T. Schneeweis, B. Gupta. The Omega measure accounts for higher asset distribution moments and thus is especially powerful for bumpy distributions where risk is not captured by volatility, skewness or kurtosis. More...
15/09/03
Performance
Vijaya B. Marisetty, George Woodward. In this article, Marisetty and Woodward considers the problem of the performance evaluation of market timers. In the fund performance evaluation literature, one of the major theoretical contributions to evaluating the market timing ability of fund managers was proposed by Merton (1981) and empirically developed by Henriksson and Merton (1981). More recently, some authors have introduced improvements to this model, including Ferson and Schadt (1996) who considered Merton’s model in the framework of a conditional version of the CAPM, where the beta depends on economic variables. But these improved models have been subject to criticism. These models suppose that managers only consider the information available on the previous period. Some authors argued that in that case, the Jensen’s alpha of the portfolio will be zero. More...
09/09/03
Performance
Kent Daniel, Mark Grinblatt, Sheridan Titman, Russ Wermers. In managing mutual funds, stock selection appears to be the main source of fees. The question then is whether the stock selection is good enough to generate performance that makes up for those fees. This question has previously been considered by different authors and tests have been realised using various models. Most studies have concluded that mutual funds do not have significant stock-picking ability. Although several studies have found evidence of persistence in mutual fund performance, this persistence has been attributed to either survival bias or benchmark errors. More...
09/09/03
Asset Allocation
Klaus Berge, William T. Ziemba. For several years, numerous articles in the financial literature have shown evidence that stock returns are partly predictable. The first studies relied on past returns. It was then demonstrated that financial and accounting variables were able to predict returns. Specifically, interest rates and E/P ratios were identified as important variables in predicting returns. Berge and Ziemba note that only a few studies have employed these two variables together. In fact, the spread between interest rates and E/P ratios appears to be a type of variable that is widely used by practitioners, though little can be found about it in the literature. In this article, the authors first describe why this type of measure is interesting from a theoretical point of view. More...
28/08/03
Performance
F. Koh, W. T. H. Koh, M. Teo. This study approaches the issue of hedge fund return persistence from two interesting angles: the selected funds invest a significant portion of their assets in Asian countries, and the Kolmogorov-Smirnov multi-period test of persistence is used (the only previous paper to use this method to test hedge fund return persistence is by Agarwal and Naik (2000)). More...
28/07/03
Performance
P.-A. Barès, R. Gibson and S. Gyger.
The authors examine the persistence of hedge fund performance in three different ways: the relative performance persistence of individual hedge funds, the performance persistence of hedge fund portfolios on a "raw" performance basis, and the performance persistence of hedge fund portfolios on a risk-adjusted basis. More...
23/07/03
Performance
M.J. Howell.
This study discusses the benefits of investing in hedge funds of a specific maturity. Young hedge funds are usually defined as those offering a track record of less than three years.
The author sorts the funds contained in the database used into deciles according to their maturity, and compares the returns of the youngest hedge funds to the whole sample median and to the returns of the oldest hedge funds. Non-adjusted returns and returns adjusted for the risk of failure are computed. More...
18/07/03
Performance
Bing Liang. Even if convenient performance indicators - associated to well-specified models - are used, performance measurement which is based on an inaccurate database is biased in all cases.
The choice of an accurate database, before investigating the problems of the return calculation, is of major interest in the context of the hedge fund industry.
The study focuses on two well-known databases marketed by TASS Management Limited and U.S. Offshore Fund Directory. More...
15/07/03
Performance
J.-F. Bacmann and S. Scholz.
The Sharpe ratio and the Sortino ratio, two very well-known performance indicators, exhibit some drawbacks when they are applied to hedge funds.
In order to improve the risk approach in the context of hedge funds, Bacmann and Scholz compare the results of the Sharpe ratio and the Sortino ratio to the results obtained through two alternative measures, the Omega measure and the Stutzer index. More...
01/07/03
Asset Allocation
Jonathan Lewellen.
Predicting returns has been a subject of interest for a long time. Initial tests used past returns to predict future asset prices, such as those conducted by Kendall (1953). Later on, additional variables were considered, including dividend yield (DY), book-to-market (B/M) and the earnings-price ratio (E/P). These variables appear to be of particularl interest in predicting asset returns, as they should be positively related to expected returns. However, empirical studies have concluded that their power to predict returns was weak. In this article, Lewellen argues that this can result from the correction of biases. More...
24/06/03
Asset Allocation
Alok Kumar.
Investment managers are becoming increasingly concerned by style investing, as demonstrated by recent studies. This article begins by giving an overview of what style investing is and then describes how this type of investing, when massively followed by investment managers, can influence stock returns.
Style investing consists of constructing portfolios by choosing assets according to the style they belong to. The mutual funds industry is now offering funds that follow the different styles. Typically, a strategy based on style creates arbitrage between a main style and a competing style, the latter having opposing characteristics to the main style: for example, growth versus value or small capitalization versus large capitalization. More...
19/06/03
Performance
B. Gupta, B, Cerrahoglu and A. Daglioglu. On the assumption that hedge fund managers pursue dynamic trading strategies, the induction of time variation to Jensen’s model (1968) is a potential source of a more accurate estimation of the parameters. A linear relationship between Beta and a set of mean zero information variables available at time t-1 enables a conditional performance evaluation model, in contrast to static models, to be obtained.
More...
19/06/03
Performance
Georges Hübner.
This article firstly gives a brief history of risk-adjusted performance measurement. The initial measures were developed after the publication of the Capital Asset Pricing Model and were based on a single index model. These measures were the Sharpe ratio, the Treynor and Black appraisal ratio, the Treynor ratio and the Jensen’s alpha. Extensions to multi-index models have been proposed, following the development of Ross’s Arbitrage Pricing Theory, but they have essentially concerned the generalization of Jensen’s alpha. The author of this article explaining the interest of Treynor’s ratio compared to other methods, presents a generalization of this ratio in the framework of a multi-index model. More...
17/06/03
Performance
Harry M. Kat and Joëlle Miffre.
Static asset pricing models imply that the risk and performances are constant over time.
Due to investment decisions based on public information and dynamic trading strategies, in the case of hedge funds, static models present the risk to be misspecified. If the risk profile is modified over the calculation period, it can have strong impact on the abnormal performance.
This assumption is in opposition with several studies which use multi-factor asset pricing models, where the risk exposure remains constant.
That is why the authors attempt to improve the statistical significance of the performance evaluation, by constructing a time-varying expected return asset pricing model. More...
12/06/03
Asset Allocation
Fabio Trojani, Paolo Vanini, Luigi Vignola.
This article considers the problem of deriving the optimal portfolio of a private investor. It is assumed that the investor initially holds a portfolio. The objective is to modify this portfolio so that it is as close as possible to the portfolio recommended by the consulting process, using the universe of instruments available to the investor, while minimizing the transaction costs and taking the investor constraints into account. This problem is given the term of the three-portfolios matching problem (TPMP). More...
05/06/03
Asset Allocation
Elmar Mertens, Heinz Zimmermann.
International portfolio managers have to decide whether or not to hedge their portfolio and how to perform this hedging. This aspect of portfolio management is related to strategic asset allocation. The value added by tactical asset allocation and the benefits of international investment in improving portfolio performance have often been considered in separate studies. In this article, Mertens and Zimmerman describe different ways of integrating currency allocation in the investment process and their effect on portfolio performance. More...
23/05/03
Asset Allocation
Stefan Engström.
The problem of mutual fund performance evaluation has been extensively described in the literature. This article initially goes back over the measures and decompositions that were developed previously. Most of these models consider the aggregation of portfolio asset returns, like, for example, Treynor and Mazuy (1966) and Henriksson and Merton (1981) who proposed decomposing fund performance into stock selectivity and market timing ability. More...
23/05/03
Asset Allocation
Alexander Kempf, Christoph Memmel.
In view of the difficulties in estimating expected returns, this article indicates the usefulness of the only efficient portfolio whose weights are independent from these estimations. This portfolio is the minimum variance portfolio, which has already been the object of several developments. The authors begin by analysing the specific properties of the true global minimum variance portfolio, the one that can be computed if the true return distribution parameters are known. They show the close link between the global minimum variance portfolio and linear regression theory. This makes it possible to use the Ordinary Least Squares (OLS) method to estimate the weights of the global minimum variance portfolio. More...
15/05/03
Performance
H. M. Kat, F. Menexe. The fact that many allocations to hedge funds are based on their track record implies that investors believe that performance persists.
This study, which considers two main aspects, is interesting. Firstly, the authors distinguish between two performance persistence approaches: the persistence in the risk-adjusted returns and the persistence in the risk profile. Kat and Menexe base their investigations on the second approach. Secondly, they distinguish between "persistence" and "predictability": the persistence of a risk profile does not imply that it can be predicted. More...
14/05/03
Performance
B. Liang. Unlike previous studies on alternative investment vehicles, Liang examines Commodity Trading Advisors (CTAs), hedge funds and funds of hedge funds as three distinctive investment classes. The distinction is due to the dramatic differences between the classes. The trading strategies, regulations and correlation structures of CTAs and hedge funds are different. The fee structures of funds of funds and hedge funds are different.
The author chooses a portfolio approach to investigate the performance and risk characteristics of the three groups. More...
14/05/03
Risk
Wang J.
In this paper, Wang compares mean-variance and mean-VaR approaches and develops a two step portfolio optimization procedure which is meant to benefit from the advantages of each approach and which appears to bypass most of their drawbacks. More...
13/05/03
Alternative Investments
Favre-Bulle A. and Pasche S.
In this thesis, Favre-Bulle and Pasche propose optimizing portfolios with the Omega measure that was initially introduced by Keating and Shadwick (2002) and comparing the results with those obtained from traditional measures such as Mean-Variance, Mean-Value-at-Risk, Mean-Adjusted Value-at-Risk (using Cornish-Fisher expansion to deal with skewness and kurtosis) and Mean Downside Deviation. Even if allocation was initially proposed in a mean-variance framework, it is hard to use these criteria for hedge funds. All the other traditional measures require some (strong) assumptions about the distribution of returns or investors’ utility function. More...
13/05/03
Risk
J. Berkowitz, J. O'Brien. This paper, written by Berkowitz and O’Brien, constitutes the first study focusing on the performance of commercial Bank VaR models. Most of the previous studies use illustrative portfolios to compare modelling approaches. The lack of empirical studies on banks' internal trading risk models is due to the proprietary nature of these models. Nevertheless, since 1996, VaR has become a standard risk measure imposed on banks in order to determine market risk capital requirements. More...
13/05/03
Indexes
W. Fung and D.A. Hsieh. The market turmoil that has prevailed for the last three years highlighted the necessity for private and institutional investors to follow well diversified investment strategies. Since alternative investment strategies are marketed as being able to post exceptional performances in bull and bear markets, an ever growing number of investors are increasing their allocation to hedge funds. However, it is well known that information concerning hedge funds is scarce and that data vendors cannot cope with this incomplete information without generating potential measurement biases. Do hedge funds still post remarkable performances after accounting for these biases? Is it possible to get a true and fair evaluation of hedge fund performance despite the presence of measurement biases? These are the two problems the authors address in this article.
More...
29/04/03
Performance
R. Kouwenberg. This study investigates the benefit of investing in hedge funds for an uninformed and passive investor, holding stocks and bonds.
In order to take into account the non-normality of hedge funds return distributions, after evaluating its effects, Kouwenberg uses an alpha with a power utility function and an extended model with option selling strategies.
The author provides computation of the alpha for each strategy and finally tests the persistence of the hedge fund returns.
More...
28/04/03
Indexes
David E. Kuenzi. With the development of numerous sophisticated investment styles, such broad indexes do not accurately reflect the specific features of certain strategies. Since benchmarks play a central role in portfolio risk management and portfolio attribution analysis, investors and fund managers may be compelled to construct “strategy” benchmarks to ensure a robust implementation of the investment process. More...
15/04/03
Performance
M. Getmansky, A. W. Lo, I. Makarov. The most common explanation for the presence of serial correlation in asset returns is a violation of the Efficient Markets Hypothesis. In an informationally efficient market, price changes must be unforecastable if they fully incorporate the expectations and information of all market participants. In the context of hedge fund returns, More...
08/04/03
Performance
Les Gulko. The author presents an ex-post performance evaluation method that takes the return and volatility of the hedge funds and their correlations with stocks and bonds into account, in the Markowitz mean-variance framework. The advantage of this method is that it gives the contribution of a hedge fund style to a market portfolio.
More...
04/04/03
Indexes
Bing Liang. While all investors are aware that measurement biases such as the survivorship bias may affect the performance of hedge fund indexes, they do not necessarily know that the magnitude of these biases is directly related to the specific characteristics of the databases. As a result, the impact of measurement biases may differ across databases. The author endeavours to shed some light on this issue by comparing two databases, namely TASS and HFR. This article not only shows that the survivorship bias differs across databases but also across investment styles within a given database. More...
02/04/03
Indexes
Clifford S. Asness, Robert Krail, John M. Liew. Since information on hedge funds is scarce, investors may be compelled to rely solely on hedge fund indexes to measure performance and/or allocate capital to alternative investment strategies. The authors argue that investors should be very cautious in doing so, as non-synchronous movement in returns may lead to an underestimation of volatility and an overestimation of the diversification benefits of alternative investment strategies. The analysis consists of using regressions of CSFB and HFR hedge fund index returns from January 1994 through to September 2000 on both contemporaneous and lagged market returns. More...
02/04/03
Performance
Greg N. Gregoriou, Fabrice Rouah. The existence of a relationship between asset size and hedge fund performance is interesting for two reasons. For the investor, it’s about taking into account the size of the fund before investing. For the fund manager, it concerns the maximal asset size he will choose. The authors deals with the impact of size on hedge fund performance by carrying out statistical tests. More...
01/04/03
Performance
Hossein Kazemi and Thomas Schneeweis. This study provides an interesting contribution to the search for an efficient hedge fund performance measurement model. According to the authors, the distributions of hedge funds returns are neither normal, nor identical through time. That is why the traditional performance evaluation models are not appropriate. Kazemi and Schneeweis propose a conditional model of performance: the Stochastic Discount Factor model. More...
01/04/03
Indexes
Ross Barry. It is well known that hedge fund indexes inherit measurement biases from the databases on which they are based. As a consequence, it is particularly important to be well aware of the origin and the consequence of potential measurement biases in commercially available databases. This article offers an interesting insight into these issues. The analysis focuses on two biases, namely the survivorship and instant history biases. It consists of a study of the TASS database from 1994 to 2001. More...
27/03/03
Indexes
Leola B. Ross, George Oberhofer. Hedge funds are poorly regulated investment funds. As a result, they follow very heterogeneous investment strategies. The authors argue that broad based indexes cannot reflect this diversity and may mask interesting features. Hence, conclusions drawn from style universe data may not be representative of individual funds. This must be taken into account in performance evaluation and/or allocation processes. More...
27/03/03
Indexes
Jimmy Liew. Hedge fund investing is gaining acceptance from an increasing number of investors but remains the preserve of High Net Worth Individuals and Institutional Investors. Consequently, as many hedge fund indexes have been launched on the market during the last 10 years, many investors are thinking about gaining exposure to hedge funds through hedge fund index investing. In this article, the author asks whether this solution is a good alternative to actively managed funds of funds. More...
27/03/03
Indexes
Gaurav S. Amin, Harry M. Kat. Hedge funds charge investors with high incentive fees (15% to 25%). Nevertheless, the lack of transparency surrounding hedge funds makes it difficult to assess to which extent they add value. The authors try to shed some light on this important issue by measuring the performance of hedge funds on a stand alone basis as well as in a portfolio. More...
27/03/03
Indexes
Ross Barry. It is well known that hedge funds’ indexes inherit measurement biases from the databases they rest on. As a consequence, it is particularly important to be well aware of the origin and the consequence of potential measurement biases in commercially available databases. This article offers an interesting insight with respect to these issues. The analysis focuses on two biases, namely the survivorship and instant history biases. It consists of a study of the TASS database from 1994 to 2001. More...
27/03/03
Indexes
Chris Brooks, Harry M. Kat. This article is of great interest for investors who are willing to invest in hedge funds. It suggests that investors should be very cautious when analysing hedge fund performance since their unique characteristics have strong implications for portfolio analysis. More...
27/03/03
Indexes
Leola B. Ross, George Oberhofer. Hedge funds are poorly regulated investment funds. As a result, they follow very heterogeneous investment strategies. The authors argue that broad based indexes cannot reflect this diversity and may mask interesting features. Hence, conclusions drawn from style universe data may not be representative of individual funds. This must be taken into account in performance evaluation and/or allocation processes. More...
27/03/03
Indexes
Jimmy Liew. Hedge fund investing is gaining acceptance from an increasing number of investors but still remains the privilege of High Net Worth Individuals and Institutional Investors. Consequently, as many hedge fund indexes have been launched on the market during the last 10 years, many investors are thinking about gaining exposure to hedge funds through hedge fund index investing. In this article, the author asks if this solution is a good alternative to actively managed funds of funds. More...
27/03/03
Indexes
Gaurav S. Amin, Harry M. Kat. Hedge funds charge investors with high incentive fees (15% to 25%). Nevertheless, the lack of transparency surrounding hedge funds makes it difficult to assess to which extent they add value. The authors try to shed some light on this important issue by measuring the performance of hedge funds on a stand alone basis as well as in a portfolio. More...
27/03/03
Indexes
Chris Brooks, Harry M. Kat. This article is of great interest for investors willing to invest in hedge funds. It suggests that investors should be very cautious when analysing hedge funds’ performance since their unique characteristics have strong implications for portfolio analysis. More...
27/03/03
Indexes
William Fung, David A. Hsieh. The authors question the quality of the information published by the hedge fund indexes available on the market. Their theory is that these indexes inherit the measurement biases of the databases they are built from. Consequently, one should be cautious when assessing hedge funds’ performances. More...
26/03/03
Performance
Guillermo Baquero, Jenke ter Horst, Marno Verbeek. This paper provide an empirical analysis of persistence in the performance of U.S. hedge funds over the period 1994-2000. The authors take the look-ahead bias into account by using a correction method. Performance persistence is examined for both raw and risk-adjusted returns. More...
14/03/03
Performance
V. Agarwal, N.Y. Naik. Hedge funds capture risk premia linked to dynamic trading strategies or spread-based strategies, and they can take both long and short positions in securities. That's why hedge funds can offer exposure to risk-factors that traditional long-only strategies cannot.
Thus, the main goal of the study is to extend the understanding of hedge funds risks to a wide range of equity-oriented hedge fund strategies. More...
03/03/03
Risk
Philippe Jorion. Since 1993, Value-at-Risk (VaR) has become an easy-to-understand standard benchmark for quantifying market risk. This paper aims to investigate the relationship between publicly disclosed VaR measures and the volatility of trading revenues for 8 major US commercial banks. More...
25/02/03
Risk Analysis
Mark Kritzman, Don Rich.
Risk is traditionally measured as the possible amount of loss at the end of the investment horizon. This may lead to underestimation of risk. This article describes two methods to consider the exposure to loss throughout the investment period. More...
01/12/02
Asset Allocation
Richard M. Ennis, Michael D. Sebastian.
Small-cap stocks are believed to offer greater expected returns than large-cap stocks, because the market is supposed to be less efficient for small stocks than for large ones. The article explains that this opinion is in fact due to performance misevaluation. More...
01/11/02
Performance Measurement
Ron Bird, David R. Gallagher.
This articles takes into account the higher moments of the distribution of returns to evaluate portfolio performance. While most of the studies consider Gaussian distributions for the returns, this study considers more real distributions. More...
01/11/02
Benchmark
Stanley B. Block, Dan W. French.
This article deals with the problem of benchmark choice in evaluating portfolio performance. Most benchmarks are value-weighted, while portfolios tend to be equally-weighted. More...
01/11/02
Hedge Fund
Andreas Signer, Laurent Favre.
This article deals with the problem of correct risk measurement for hedge funds. As hedge funds returns are not distributed according to a normal distribution, it is necessary to use a risk measure that takes the real shape of the distribution into account. This article proposes a modified value-at-risk, which takes skewness and kurtosis into account. More...
01/11/02
Asset Allocation
Gerard W. Buetow, Jr., Ronald Sellers, Donald Trotter, Elaine Hunt, Willie A. Whipple, Jr. .
Managing a portfolio presupposes that target asset allocation weights have been initially defined. The portfolio will then encounter weighting drifts compared to the allocation. The problem for managers is to decide when to rebalance their portfolios to correct these drifts, without losing added value, for example, through transaction costs. More...
01/11/02
Style Analysis
Laurens A. P. Swinkels, Pieter J. van der Sluis.
This article deals with the problem of fund style analysis. Fund style analysis is very useful for giving us a precise idea of the style of funds, because fund managers do not always pursue the style that they announce. More...
01/11/02
Hedge Fund
B. Wade Brorsen, John P. Townsend.
This article studies the performance of managed futures, using data from commodity trading advisors (CTAs) and performing regression analysis, since previous studies were based on non parametric tests. The result of the study is that performance persistence exists and is statistically significant, but that this persistence is very small compared with the noise in the data. More...
01/11/02
Risk
Mark Kritzman, Kenneth Lowry, Anne-Sophie Van Royen.
In this article risk aversion is calculated using portfolio holdings data with a reverse mean-variance optimisation process. The risk aversion values of several countries are compared. The authors demonstrate that risk aversion calculated in that way helps to predict bond and stock returns.
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01/11/02
Mutual Fund
Larry J. Prather, Karen L. Middleton.
This article investigates whether a fund managed by a team is able to achieve better performance than a fund managed by only one manager. More...
01/11/02
Asset Allocation
Pavlo Krokhmal, Stanislav Uryasev, Grigory Zrazhevszky.
This article compares several risk management methods for portfolios of hedge funds and considers the problem of constructing optimal funds of hedge funds. More...
01/11/02
Asset Allocation
Lisa M. Plaxco, Robert D. Arnott.
It is necessary to rebalance a portfolio to compensate for the drifts from the benchmark. Drifts can produce superior performance during certain periods, but they also modify the risk of the portfolio. This article compares various methods of portfolio rebalancing in order to control risk and generate alphas. More...
01/11/02
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