EDHEC Publications
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)).
Tactical Style Allocation - A New Form of Market Neutral Strategy
2003
Even though there is little evidence of predictability in stock specific risk in the absence of private information, most equity market neutral managers still rely on stock picking as the preferred way to generate abnormal returns. In this paper, we document the benefits of a new form of market-neutral portfolio strategy that aims at deliver absolute return over the full business cycle through systematic equity style timing decisions. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Alternative Investments.
How to Price Hedge Funds: From Two- to Four-Moment CAPM
2003
In the last decade, the hedge fund industry grew impressively. Many studies show that hedge funds have a superior performance and that the introduction of hedge funds in a classical portfolio enhances the portfolio's performance. The attractive performance of hedge funds may be due to inadequate measurement techniques of the risk-return profile of hedge funds. The main aim of this paper is to investigate how to price hedge funds and, in particular, the validity of the traditional asset pricing models in measuring the risk-return trade-off in hedge fund investment.
Risk Measurement of Investments in the Satellite Ring of a Core-Satellite Portfolio: Traditional versus Alternative Approaches
2003
This paper provides a risk framework for fiduciaries considering using a core-satellite approach to investing. While the article mainly covers the additional risk measurement techniques, which are needed when investing in hedge funds, its recommendations are also relevant for other investments that have default, devaluation, and/or liquidity risks associated with them. While the article’s focus is on quantitative techniques, the author notes that a fiduciary must also understand the economic basis for each investment’s returns.
The Alpha and Omega of Hedge Fund Performance Measurement
2003
That hedge funds start gaining wide acceptance while they still remain a somewhat mysterious asset class enhances the need for a better measurement their performance. This paper is an attempt to test the ability of hedge fund managers to generate superior performance.
Optimal Allocation to Hedge Funds: An Empirical Analysis
2003
What percentage of their portfolio should investors allocate to hedge funds? The only available answers to the above question are set in a static mean-variance framework, with no explicit accounting for uncertainty on the active manager’s ability to generate abnormal return, and usually generate unreasonably high allocations to hedge funds. In this paper, we apply the model introduced in Cvitanic, Lazrak, Martellini and Zapatero (2002) for optimal investment strategies in the presence of uncertain abnormal returns to a database of hedge funds. Wefind that the presence of model risk...
EDHEC Alternative Indexes
2003
Different hedge fund indexes available on the market are constructed from different data, according to diverse selection criteria and methods of construction, and they evolve at differing paces. As a result of this heterogeneity, investors cannot rely on competing hedge fund indexes to obtain a “true and fair” view of hedge fund performance. Investors are therefore at a loss when selecting benchmarks. As a response to the needs of investors, the Edhec Risk and Asset Management Research Center proposes an original solution by constructing an “index of indexes.” The aim of the methodology used...
Evaluating Hedge Fund Investments: The Role of Pure Style Indices
2003
Over the past decade, the hedge fund industry has grown – big time. According to estimates, the number of hedge funds increased from 2,000 to 8,000, assets under management went from US $67 billion to US $800 billion, and inflows of money to hedge funds have never been greater. This growth was essentially driven by the attractive risk-adjusted performance achieved by hedge funds, their ability to protect capital in negative equity markets, and the shrinkage in proprietary trading activities, which coincided neatly with a welter of hedge fund launches.
Indexing Hedge Fund Indexes
2003
As a response to the needs of investors, the Edhec Risk and Asset Management Research Centre proposes an original solution by constructing an “index of indexes”, the performance of which is posted on a dedicated web site (www.edhec-risk.com). The aim of the methodology used to construct this “index of indexes” is to construct a benchmark with degrees of representativity and stability that are significantly higher than those of the indexes available on the market. This methodology was first introduced in Amenc, Martellini (2002a).
Portable Alpha and Portable Beta Strategies in the eurozone: Implementing Active Asset Allocation Decisions using Equity Index Options and Futures
2003
In this paper, we show how portfolio managers in the Euro-zone can benefit from using derivatives markets to actively manage their asset allocation decisions in a systematic manner. Using a robust econometric process based on a non-linear multi-factor thick and recursive modeling approach, we report statistically and economically significant evidence of predictability in Dow Jones EURO STOXX 50 excess return. These econometric forecasts can be turned into active portfolio decisions and implemented via Eurex index futures to generate active asset allocation portable alpha benefits. A revisited...
The Generalised Treynor Ratio
2003
This paper presents a generalization of the Treynor ratio in a multi-index setup. The solution proposed in this paper is the simplest measure that keeps Treynor's original interpretation of the ratio of abnormal excess return (Jensen's alpha) to systematic risk exposure (the beta) and preserves the same key geometric and analytical properties as the original single index measure.
An Analysis of Hedge Fund Performance 1984-2000
2003
Using one of the largest hedge fund databases ever used (2796 individual funds including 801 dissolved), this paper investigates hedge funds performance using various asset pricing models, and a new factor that takes into account the fact that some hedge funds invest in emerging bond markets.
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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.
