EDHEC Publications
Absolute Returns in Commodity (Natural Resource) Futures Investments
2005
In this article, the authors introduce readers to commodity (natural resource) futures programs. They begin the article by describing the present investment landscape as one where return compression in a number of popular hedge fund strategies has led absolute-return investors to investigate other promising return sources. This includes the highly volatile natural-resource markets, which Lammey (2004) describes as a "paradise for speculators."
Pricing Traditional versus Alternative Asset Management Services
2005
The delegation of asset management services is a source of potential agency problems between investors and their portfolio managers. Most of these problems can be avoided by using an adequate compensation theme. While the academic literature tends to be somewhat inconclusive as to whether or not, and to what degree optimal compensation should be linked to relative or absolute performance, industry practice seems to show a clear pattern: mutual funds charge an asset-based fee, while hedge funds charge both an asset-based fee and a performance fee. In this article, the author discusses the...
From Delivering to the Packaging of Alpha
2005
In this paper, "From Delivering to the Packaging of Alpha. Illustration from Active Bond Portfolio Management: Using Fixed-Income Derivatives to Design Hedge Fund Type Offerings that Better Fit Investors’ Needs", the authors emphasize the need for the hedge fund industry to adopt a consumer (investor)-driven approach, as opposed to the current producer (manager) perspective, and call for the emergence of new types of offering with characteristics better suited to the needs of institutional investors. Using active bond portfolio management as an example, they present evidence on the use of...
Hedge Funds from the Institutional Investor’s Perspective
2005
As a consequence of entering a more mature stage, the hedge fund industry has extended its investor base to institutional investors, who are now faced with a large number of product offerings including not only single hedge funds, but also funds of funds and, more recently, investable indexes. Although the existing literature seems to concur on the interest of hedge funds as valuable investment alternatives, there still remain a large a large number of institutional investors who wonder whether they should invest in hedge funds, and more importantly, how they should do it. In order to address...
Static Mean-Variance Analysis with Uncertain Time Horizon
2005
In this paper, we generalize Markowitz analysis to the situations involving an uncertain exit time. Our approach preserves the form of the original problem in that an investor minimizes portfolio variance for a given level of the expected return. However, inputs are now given by the generalized expressions for mean and variance-covariance matrix involving moments of the random exit time in addition to the conditional moments of asset returns. While efficient frontiers in the generalized and the standard Markowitz case may coincide under certain conditions, we demonstrate, by means of an...
Hedge Fund Strategy Benchmarks: Tricks of the Light or Lighthouses?
2005
The construction of an appropriate benchmark is one of the major challenges of the performance measurement process. Without quality benchmarks, it is not possible to differentiate between returns due to the investment style of the manager and returns due to the talent of the manager, which in turn makes it difficult to measure relative returns. This paper examines the issue of hedge fund strategy benchmarks in the light of improvements in hedge fund index construction methodologies and management principles, and with the launch of new series of investable hedge fund indices. The paper notably...
Exploiting Predictability in the Time-Varying Shape of the Term Structure of Interest Rates
2005
This paper presents evidence of predictability in the time-varying shape of the U.S. term structure of interest rates using a robust recursive modelling approach based on a Bayesian mixture of multi-factor models. We find that variables such as default spread, equity volatility, short-term and forward rates, among others, can be used to predict changes in the slope of the yield curve, and also, albeit to a lesser extent, changes in the curvature of the yield curve. By using systematic trading strategies based on butterfly swaps, we also find that this evidence of predictability in the shape...
Hedge Fund Indices from an Academic Perspective: Reconciling Investability and Representativity
2004
Following a growing concern among investors about the quality of hedge fund index return data, and given the lack of capacity and transparency specific to that industry, this paper questions from an academic perspective whether it is feasible or not to design hedge fund benchmarks satisfying all defining properties for a good index. In particular, in an attempt to test whether achieving investability necessarily comes at the cost of representatitivity, as sometimes claimed by hedge fund index providers, we borrow from the asset pricing literature the concept of factor replicating portfolios...
History of the Risk Concept and Risk Modeling
2004
What is risk? The answer is far from simple. The definition depends on the context and is highly subjective. A first attempt is to define risk as the possibility of something unexpected occurring. But what could the constituents of those expected and unexpected events be? Again there is no single answer. The field of finance is a symptomatic example where risk is multiform. It is usual to distinguish between market risk, credit risk, liquidity, operational and legal risks.
The Benefits and Costs of Illiquidity
2004
This article discusses how to explicitly take into consideration the illiquid nature of alternative investments, particularly including hedge funds. It specifically examines the benefits and costs of illiquidity along with proposed quantitative adjustments that enable one to compare illiquid investments on a level playing field with liquid investments.
In Search of Quality Benchmarks for Hedge Fund Strategies
2004
Over the last few years, alternative investment strategies have dramatically gained in popularity. Initially reserved for High Net Worth Individuals (HNWI), they progressively drew the attention of individual and institutional investors, to reach approximately 1 trillion dollars in assets under management today. However, while HNWI were looking for absolute returns, private and institutional investors are more focused on capital preservation and/or risk-adjusted performance.
Using Index Options to Improve the Performance of Dynamic Asset Allocation Strategies
2004
It has long been argued that equity managers can use derivatives markets to help implement a systematic risk management process designed to enhance the performance of their portfolio (see for example Ineichen (2002) for a recent reference). These derivatives instruments can be used in the context of completeness portfolios that are designed not to interfere with the original portfolio composition, so that they can be used to generate what have been labeled portable beta benefits (Amenc et al. (2004)). Consider for example the case of long/short equity hedge fund managers. A revisited version...
The Fund of Hedge Fund Reporting Puzzle: Reconciling Investors’ Expectations and Fund Managers’ Constraints
2004
The development of alternative investment has not yet been accompanied by a genuine consideration of the specific characteristics of the risks and returns of hedge funds with regard to the provision of information to investors. This inadequacy came to light in a study published by EDHEC in 2003, a study that showed that a very large majority of European hedge fund managers were satisfied with a reporting method designed for investment in traditional asset classes. This method proposes a mean variance-structure that is inappropriate for the risk and return profiles of alternative investment...
On the Role of Hedge Funds in Institutional Portfolios
2004
Hedge funds do not easily fit into the current way institutions go about investing. In this article, the author reviews both academic and practitioner research from the standpoint of a hypothetical institutional investor who is looking into whether hedge funds make sense for their portfolio. A revisited version of this paper was published in the Spring 2004 issue of The Journal of Alternative Investments.
The Benefits of Bond ETFs for Institutional Investors - The Natural Vehicle for a Core-Satellite Approach
2004
Recent market difficulties have drawn attention to the risk management practices of institutional investors. Particularly significant was the fact that negative equity market returns were eroding plan assets at the same time as declining interest rates were increasing benefit obligations. These events have spotlighted the weakness of current funding standards for corporate defined benefit pension plans. They have also emphasized the weakness of investment practices.
Be Active with your Bond Trackers
2004
Newly launched fixed-income Exchange Traded Funds (ETFs) have specifically been designed to track bond market indices, and share many of the same benefits of equity ETFs, including in particular lower costs, transparency, buying and selling flexibility, all day tracking and trading. While it has often been argued that ETFs were natural investment vehicles for implementing passive indexing strategies, we show in this paper that the benefits of ETFs are actually much larger than traditionally reported, as these instruments can also be used to implement almost the full range of existing...
Hedge Fund Indices: Investable, Non-Investable and Strategy Benchmarks
2004
In the mutual fund industry, which is based on a passive investment approach, and where respecting the tracking error is an inevitable notion, the use of indices is necessary in order to play on exposure to the market. In the hedge fund universe, where it is frequently said that performance is extracted from managers, reflecting active asset management, the implementation of hedge fund indices may be surprising, because the notion of index is commonly associated with the notion of passive management. However, picking the best performers in the hedge fund universe appears to be a very...
A Survey of the Literature on Hedge Fund Performance
2004
The issue of performance measurement in the hedge fund industry has led to literature that is both abundant and controversial. The explanation for this complexity lies in the particular features of alternative funds. Hedge funds invest in a heterogeneous range of financial assets and cover a wide range of strategies that have different risk and return profiles. Even though the current studies on hedge fund performance appear to be confusing, due to conflicting conclusions and criticism of the methods employed in previous papers, they contribute to an improvement in the knowledge of...
Taking a Close Look at the European Fund of Hedge Funds Industry- Comparing and Contrasting Industry Best Practices and Academic Recommendations
2004
Over the last few years institutional investors’ traditional portfolios have failed to meet their objectives in terms of risk and performance. Investors have thus shown growing interest in new forms of diversification, especially in investment vehicles that offer better protection during extreme market conditions. A revisited version of this paper was published in the Winter 2004 issue of the Journal of Alternative Investments.
Dynamic Asset Pricing Theory with Uncertain Time-Horizon
2004
This paper addresses the problem of pricing and hedging a random cash-flow received at a random date in a general stochastic environment. We first argue that specific timing risk is induced by the presence of an uncertain time-horizon if and only if the random time under consideration is not a stopping time of the filtration generated by prices of traded assets. In that context, we provide an explicit characterization of the set of equivalent martingale measures, as well as a necessary and sufficient condition for a convenient separation between adjustment for market risk and timing risk. A...
The Capacity Implications of the Search for Alpha
2004
If hedge funds are exploiting market inefficiencies, this means that other investors are supplying those inefficiencies. This means that, unfortunately, we can’t all profit from exploiting inefficiencies. Therefore, there is a natural cap on the potential size of the hedge fund industry, assuming that hedge funds are indeed exploiting inefficiencies rather than taking in risk premiums.
Finding the Sweet Spot of Hedge Fund Diversification
2004
Hedge funds are often thought of as being high-risk investments and many investors in the past have shied away from them for fear of making large losses. However, over the recent years, hedge funds have generally substantially outperformed equities, with much lower volatility. As a consequence, they are now in strong demand, particularly when one remembers that any risk associated with hedge fund investing diminishes in importance when the funds are repackaged into fund of funds products. A revisited version of this paper was published in the April 2004 issue of the Journal of Financial...
Hedge Funds Investing: A Quantitative Look Inside the Black Box
2004
There is an increasing amount of evidence that shows the benefits of considering hedge funds as an asset class at the strategic asset allocation level. The investors’ greatest challenge remains the identification of desirable investment vehicles, since very little formal quantitative analysis of hedge funds has been done in the past. In this paper, we suggest an innovative approach to hedge fund investing, which is valid at the individual fund level as well as at the aggregate portfolio level (e.g. portfolio of hedge funds). This approach only relies on hedge funds historical returns. We...
A Detailed Analysis of the Construction Methods and Management Principles of Hedge Fund Indices
2003
The aim of this document is to provide a detailed presentation of the different hedge fund indices in order to highlight their strengths and weaknesses. To analyse the reasons for the heterogeneity of their performances, we will focus on the following five points: Transparency & Independence, Accuracy of the data and punctuality, Stability, Representativity, Purity. The first three points will allow us to provide details on the index construction methods. The following two points will allow us to understand the consequences of the heterogeneity of the construction methods in terms of...
Edhec European Asset Management Practices Survey
2003
EDHEC has conducted a major survey into the practices of the leading 400 European asset management firms which generated responses from 60 companies. The survey is the first study conducted in Europe dealing with the application of the results of academic research within investment management companies. The survey results reveal that in spite of their extensive knowledge of the concepts involved in research into portfolio management and the progress made, the major European asset managers were either not implementing them or not adopting them rapidly as part of their investment management...
Edhec European Alternative Multimanagement Practices Survey
2003
On 11th December 2003 in Paris, Edhec presented the results of its survey on alternative multimanagement in Europe, the Edhec European Alternative Multimanagement Practices survey. This study, sponsored by FIMAT, is based both on a review of all the professional and academic research on alternative investment and a survey of the practices of European multimanagers, to which 61 firms (investors, advisors and funds of funds) replied, representing a total of 136 billion euros under management. The key findings of this study were published in the March 2004 issue of The Journal of Financial...
The Benchmark's Benchmark: Measuring the Performance of a Manager's Long-Term Strategy
2003
When investment managers construct strategy benchmarks and manage their portfolios against them, they are making an implicit bet that some subset of the broader investment universe will produce better risk and return characteristics than a similar published index over the long term. Despite the long-term focus of this decision, it is nonetheless active in nature. Strategy benchmark performance should thus be evaluated as a source of manager value-added.
Evaluating a Trend-Following Commodity Index for Multi-Period Asset Allocation
2003
The Mt. Lucas index provides a systematic approach for capturing a portion of the return of trend-following commodity traders. The authors analyze the Mt. Lucas Index across different historical periods, evaluating its performance within a multi-period asset allocation framework. Their results indicate that the index improves the overall return/risk characteristics of the multi-period asset allocation model. They show that the total return consists of: 1) T-Bill returns on marginable assets, 2) static returns from trendfollowing futures markets, and 3) rebalancing gains. The importance of the...
Desperately Seeking Pure Style Indexes
2003
There is an urgent need for improved measurement and benchmarking of size and book-to-market (style) performance. Given the proliferation of choice, a potentially serious problem is that existing style indexes can provide a somewhat confusing picture of the return on these factors.
A Stochastic Network Approach for Integrating Pension and Corporate Financial Planning
2003
This paper presents a multi-period stochastic network model for integrating corporate financial and pension planning. Pension planning in the United States has gained importance with the population aging and the growth of retirement accounts. In certain cases, the pension plan assets are several times larger than the value of the company itself (e.g. General Motors – Market cap: $19 billion, Pension plan assets: $67 billion, Estimated pension fund deficit: $25 billion – in December 31, 2002; see General Motors Corporation (2003)).
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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.
