EDHEC Publications
Hidden Liquidity in a Pure Order-Driven Market
2006
This letter focuses on hidden orders and shows how they contribute to liquidity. Based on a rebuilt order book from Euronext data, the part of liquidity which is not disclosed to market participants is described and its determinants are analyzed. A revisited version of this paper was published in the July 2006 issue of Finance Letters.
Derivatives Strategies for Bond Portfolios
2006
In this paper, the authors examine how standard exchange-traded fixed-income derivatives (futures and options on futures contracts) can be included in a sound risk and asset management process so as to improve risk and return performance characteristics of managed portfolios. The results show that the non-linear character of the returns on protective option strategies offers appealing risk reduction properties in the pure asset management context. Consequently, such strategies should optimally receive a significant allocation, especially when investors are concerned with minimising extreme...
Backwardation and Commodity Futures Performance: Evidence from Evolving Agricultural Markets
2006
The recent performance of commodities has spurred interest in the various sources of returns to commodity investment. The underlying sources of return include the potential return due to backwardation. The extent of backwardation existing in various commodities depends both on the actual commodity examined and the changing characteristics of that particular commodity market. In this paper, we examine the role of backwardation in the performance of passive long positions in soybeans, corn, and wheat futures over the period, 1950 to 2004. We find that over this period, backwardation has been...
Inferences about the Amaranth Case and the Emerging Maturity of the Hedge Fund Industry
2006
The Amaranth case is surprising in many ways. It is definitely a surprise that a well-respected multi-strategy hedge fund could lose about $6-billion in little over a week. It is perhaps an even greater surprise that such a loss would have little knock-on effects on the hedge fund industry and the wider capital markets. This paper will focus on providing new inferences on the riskiness of Amaranth’s trading strategies.
The Law and Economics of Self-Dealing
2006
This paper presents a new measure of legal protection of minority shareholders against expropriation by corporate insiders: the anti-self-dealing index. Assembled with the help of Lex Mundi law firms, the index is calculated for 72 countries based on legal rules prevailing in 2003, and focuses on private enforcement mechanisms, such as disclosure, approval, and litigation, governing a specific self-dealing transaction. This theoretically-grounded index predicts a variety of stock market outcomes, and generally works better than the previously introduced index of anti-director rights. A...
Cash Equity Transaction Cost Analysis: State of the art … and beyond
2006
MiFID is the second step in the harmonization of the European capital markets industry and intends to adapt the first Investment Services Directive (ISD 1 issued in 1993) to the realities of the current market structures. After having clarified the nature of the new regulation, this paper first describes the role of Transaction Cost Analysis in the fulfilment of the best execution obligation as well as the limits of existing frameworks. Then, the paper presents a new methodology that makes it possible to measure the quality of execution as part of peer group review and identify whether the...
La problématique du taux d’actualisation des concessionnaires d’autoroutes : le cas des ASF
2006
L’objectif de ce rapport a été, dans un premier temps, de trancher le débat méthodologique sur le choix de la valeur du taux d’actualisation des concessionnaires autoroutiers dans le cadre de leur actuelle privatisation. De nombreuses polémiques sont nées en référence à un rapport du Commissariat général au Plan de février 2005, qui conclut que les projets d’investissements publics doivent être réalisés sur 17/23 la base d’un taux d’actualisation de 4%. A notre avis, ce taux ne peut pas être retenu dans le cadre d’une valorisation effectuée par un investisseur privé, car il n’intègre...
Determinants of Funds of Hedge Funds' Performance
2006
Despite institutional investors’ growing interest in funds of hedge funds, little attention has been paid so far to their added value and/or the sources of their added value. This is all the more striking in that funds of funds are far from transparent and are, with their double-fee structure, relatively costly investment vehicles. The objective in this paper is to fill that gap and find out whether funds of funds add value through strategic allocation and active management. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Investing.
Country-Specific ETFs: An Efficient Approach to Global Asset Allocation
2006
The article shows that country-specific exchange-traded funds (ETFs) enhance global asset allocation strategies. Because ETFs can be sold short even on a downtick, global strategies that diversify risk across country-specific ETFs generate efficiency gains that cannot be achieved by simply investing in a global index open- or closed-end fund. Besides, the benefits of international diversification can be achieved with country-specific ETFs at low cost, with low tracking error and in a tax-efficient way. For all these reasons, country-specific ETFs may be considered serious competitors to...
Disorderly exits from crowded trades? - On the systemic risks of hedge funds, A reply to the ECB's statement on hedge funds
2006
An article in the June 2006 edition of the European Central Bank’s Financial Stability Review (FSR) claims that hedge fund activities pose considerable risk to the financial system. We disagree with this conclusion, which is based on mere speculation. We outline the fallacies in the reasoning of the FSR article and makes some propositions on how to assess the welfare impacts of hedge funds. In particular, we argue that it would be worthwhile for financial regulators to work towards obtaining data on hedge fund leverage and counterparty credit risk. Such data would allow a reliable assessment...
The Risks of Commodity Investing
2006
This article covers investment in commodities through futures contracts. It notes the unique sources of risk and return for such investments and also discusses the factors that one should take into consideration before deciding upon how much of a portfolio should be in commodities. We will see how an investment in commodities can be used as either a diversifier for a traditional portfolio or as a source of returns, depending on the market environment. Finally, it is argued that some of the considerations that apply to equity investing are also relevant for commodity investing.
Separating the Wheat from the Chaff: Backwardation as the Long-Term Driver of Commodity Futures Performance; Evidence from Soy, Corn and Wheat Futures from 1950 to 2004
2006
In this paper, the authors examine the role of backwardation in the performance of passive long positions in soybeans, corn and wheat futures over the period of 1950 to 2004. They find that over this period, backwardation has been highly predictive of the return of a passive long futures position when measured over long investment horizons. The share of return variance explained by backwardation rises from 24% at a one-year horizon to 64% using five-year time periods. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Alternative Investments.
Managing Pension Assets: From Surplus Optimization To Liability-Driven Investment
2006
In this paper, the author considers an intertemporal portfolio problem in the presence of liability constraints. Using the value of the liability portfolio as a natural numeraire, he finds that the solution to this problem involves a three fund separation theorem that provides formal justification to some recent so-called liability-driven investment solutions offered by several investment banks and asset management firms, which are based on investment in two underlying building blocks (in addition to the risk-free asset), the standard optimal growth portfolio and a liability hedging portfolio...
Measuring Risk-Adjusted Returns in Alternative Investments
2006
Academic criticism of classic Capital Asset Pricing Model (CAPM) performance measures is not new. Until recently it was fine to use the Sharpe ratio as a way of summarizing the attractiveness of an investment. Only now have the shortcomings of using traditional performance measures to evaluate all manner of strategies become relevant to investors. This article touches on the problems with using traditional performance evaluation methods and summarize the state-of-the-art in alternative performance evaluation techniques. A revisited version of this paper was published in Quantitative Finance...
The Risk Considerations Unique to Hedge Funds
2006
A distinguishing feature in evaluating the risk of hedge fund strategies is the relative paucity of data, as noted by Feldman et al (2002). This creates great discomfort in attempting to apply statistical techniques to sparse datasets. This article will discuss five further approaches that academics and practitioners have proposed since this summer for addressing the risk considerations that are unique to hedge funds. A revisited version of this paper was published in Quantitative Finance (2002) 2:6 pp. 409-411.
Structural Sources of Return and Risk in Commodity Futures Investments
2006
By now it has become well-known that commodities have had superior performance over the past four and a half years; commodity investing has become a sign of sophistication. Because commodity index investing has grown from an obscure, niche strategy to a more widely accepted investment, there has been a need to better understand the drivers of historical commodity returns and risks. An investor would presumably then be in a better position to make informed judgments on the future prospects of a commodity investment.
EDHEC European Alternative Diversification Practices Survey
2006
The results of the EDHEC European Alternative Diversification Practices Survey, which enabled EDHEC to produce a detailed assessment of current institutional practices in Europe, were presented to a distinguished group of institutional investors at the EDHEC Institutional Investor Summit in London on February 14th. The study generated responses from 151 European institutional investors representing, at 30/09/2005, a total volume of over one trillion euros of assets under management. The survey shows that 51% of European institutional investors are already exposed to hedge fund strategies....
A Long-Term Perspective on Commodity Futures Returns
2006
This paper reviews 75 years of literature on the commodity futures markets, examining various theories on what motivates participants in the futures markets, including hedgers, speculators, and now investors. It then discusses how term structure should be the primary driver of (historical) long-term commodity futures returns.
The EDHEC European ETF Survey 2006
2006
In a new survey, The EDHEC European ETF Survey 2006, the EDHEC Risk and Asset Management Research Centre has carried out an in-depth study on the use of ETFs (Exchange-Traded Funds) by European investors. The results of the survey show that following rapid growth, ETFs are being widely used by European institutional investors, private bankers and asset managers. The increasing popularity of ETFs is reflected in the responses of survey participants. More than half of the respondents are current or planned users of ETFs in equity investments (61%), and this is the case for more than a quarter...
EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle
2006
In a little over a week, Amaranth Advisors, a respected, diversified multi-strategy hedge fund, lost 65% of its $9.2 billion assets. In a paper entitled ‘EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle’, noted commodities expert Hilary Till, Research Associate with the EDHEC Risk and Asset Management Research Centre and Principal of Premia Capital Management, LLC, examines how Amaranth could have suffered such massive losses and draws lessons from this debacle for investors, funds of fund & energy fund risk managers, multi-strategy hedge fund managers, policy makers,...
A Review of the Differences between Traditional Investment Programs and Absolute-Return Strategies
2006
Given the ongoing stock market downdraft since March 2000, U.S. mutual fund inflows have dramatically slowed down while hedge fund investing has exploded. Some have argued that there is an accelerating convergence between the hedge fund industry and traditional institutional fund management. This article will argue the opposite: that in a very fundamental way, these two investment industries are still quite distinct. A revisited version of this paper was published in Quantitative Finance (2003) 3:3 pp. C42-C48.
Response to the "Statement of the Financial Economists Roundtable on Hedge Funds"
2006
Following its meeting in Sonoma, California on July 10-11, 2005, the Financial Economists Roundtable (FER), an international group of senior financial economists, issued a statement in which it warned about the risks involved in investing in hedge funds. The EDHEC Risk and Asset Management Research Centre, which has carried out a multi-faceted research programme on hedge funds over the past three years, has published a paper by Noël Amenc, PhD, and Mathieu Vaissié in response to the FER statement in which it comments on the FER’s recommendations.
Comparative Analysis of Hedge Fund Returns
2006
Hedge funds have an absolute return performance objective stated independently of the global market conditions. Nevertheless they have been compared to classical bond and equity indices by academics since the late 90s. Independently of their absolute or relative performance it is of particular importance to determine if some hedge funds consistently outperform their peers. This is exactly the objective of this study: Do some hedge funds consistently and significantly outperform others? Do some individual funds or some strategies continuously create alpha in comparison to others?
Commodities – Active Strategies for Enhanced Return
2005
In this article, the authors note how a set of active commodity strategies could potentially add value to an investor’s commodity allocation. But they also emphasize the due care that must be taken in risk management and implementation discipline, given the “violence of the fluctuations which normally affect the prices of many … commodities,” as Keynes (1934) put it. A revisited version of this paper was published in the Fall 2005 issue of The Journal of Wealth Management.
Investing in Hedge Funds: Adding Value through Active Style Allocation Decisions
2005
One of the by-products of the bull market of the 90’s has been the consolidation of hedge funds as an important segment of financial markets. It was recently announced that the value of the hedge fund industry worldwide had passed the $1 trillion mark for the first time, with approximately 7,000 hedge funds in the world, around 1,000 of which were launched in 2003. One of the key reasons behind the success of hedge funds in institutional money management is that such alternative investment strategies seem to provide diversification benefits with respect to other existing investment...
Edhec Funds of Hedge Funds Reporting Survey
2005
In 2004, Edhec launched an international consultation process on the implementation of a new framework for Funds of Hedge Funds reporting. This consultation process was based on a series of recommendations proposed by Edhec with regard to the academic state-of-the-art on risk measurement in the alternative universe. The results of this consultation were presented to a panel of journalists on February 17th in London at a meeting hosted by FIMAT. A revisited version of this study was published in The Journal of Risk Finance 1st Quarter 2006.
Dynamic Portfolio Choice with Parameter Uncertainty and the Economic Value of Analysts’ Recommendations
2005
In this paper, the authors derive a closed-form solution for the optimal portfolio of a non-myopic utility maximizer who has incomplete information about the “alphas”, or abnormal returns of risky securities. They show that the hedging component induced by learning about the expected return can be a substantial part of our demand. A revisited version of this paper was published in the Winter 2006 issue of the Review of Financial Studies.
Structured Forms of Investment Strategies in Institutional Investors’ Portfolios
2005
Institutional investors in general and pension funds in particular have been dramatically affected by recent market downturns. This seems to be surprising given that an increasingly thorough range of structured products has been developed over the past few years, which allows investors to tailor the risk-return profile of their portfolio in a more efficient way than simple linear exposure to traditional asset classes. The salient characteristic of structured products is the repackaging of strategies that involve long and short positions in derivatives and the underlying or a risk-free asset...
Is there a gain to explicitly modelling extremes? A risk management analysis
2005
When risk managers make decisions, they need them to be based upon reliable measures. Strong assumptions are often made to simplify the risk estimation process and there has to be a trade-off between ease of estimate and accuracy. In this paper, “Is there a gain to explicitly modelling extremes? A risk measurement analysis”, Jean-Christophe Meyfredi of the Edhec Risk and Asset Management Research Centre develops a copula-based approach in order to estimate the Value-at-Risk of portfolios containing financial assets. He proposes a survival copula, the Heavy Right Tail copula, which could solve...
The Right Place for Alternative Betas in Hedge Fund Performance: An Answer to the Capacity Effect Fantasy
2005
Two studies, by Watson Wyatt and UBS (both from March 2005), give a pessimistic view of the hedge fund industry’s capacity to generate long-term returns, due to its increasing size. Unfortunately, these studies focus almost exclusively on alpha. In the present paper, we show the importance of considering not only the exposure to the market (the traditional beta), but also the other exposures (the alternative betas) to cover all the sources of hedge fund returns. To do so, we examine the real extent to which the variability and level of hedge fund returns are affected by (static) betas,...
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About EDHEC
Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 15 business schools. Fully international and directly connected to the business world, EDHEC commands a strong reputation for research excellence and the ability to train entrepreneurs and managers capable of breaking new ground. EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses. The School’s teaching is inspired by its research work and a focus on “learning by doing”, all with the aim of equipping people with the skills to succeed in business.
