EDHEC Publications
Mass Customisation versus Mass Production in Retirement Investment Management: Addressing a "Tough Engineering Problem"
2017
Existing financial products marketed as “retirement investment solutions” do not meet the needs of future retirees, which involve securing their essential goals expressed in terms of minimum levels of replacement income (focus on safety), while generating a relatively high probability of achieving their aspirational goals expressed in terms of target levels of replacement income (focus on performance). Meaningful solutions should therefore combine safety and performance to meet this dual objective.
Smart Beta Replication Costs
2017
This paper provides an explicit estimate of the costs applied to a range of smart beta strategies and analyses the impact of different implementation rules or stock universes. The objective is to assess transaction costs of smart beta strategies in order to contrast the gross returns of such strategies shown in backtests with estimates of net returns that are actually available to investors when considering transaction costs.
Measuring Volatility Pumping Benefits in Equity Markets
2017
It has been argued that portfolio rebalancing, defined as the simple act of resetting portfolio weights back to their original weights, can be a source of additional performance. This additional performance is known as the rebalancing premium, also sometimes referred to as the volatility pumping effect or diversification bonus because volatility and diversification turn out to be key components of the rebalancing premium. The purpose of this paper is to provide a thorough numerical and empirical analysis of the volatility pumping effect in equity markets and to examine the conditions under...
Commodity Futures Trading Strategies: Trend-Following and Calendar Spreads
2017
This brief article discusses the most common strategies employed by futures traders, namely trend-following and calendar-spread trading. One typically finds that institutionally-scaled futures programs employ trend-following algorithms. Here, the key is employing such algorithms across numerous and diverse markets such that the overall portfolio volatility is dampened. On the other end of the spectrum are calendar-spread strategies. These strategies typically have limited scalability but individually can potentially have quite consistent returns. This is a working paper version of an...
The Commodity Derivatives Markets from a Broadly Conceptual Perspective
2017
This is a working paper version of a set of articles that was later published in the Spring 2017 Global Commodities Applied Research Digest. This collection of articles covers the commodity derivatives markets from a broadly conceptual perspective. Specifically, this set of articles reviews (a) the potentially persistent sources of return in the commodity futures markets; (b) the differing risk-management priorities for commercial versus speculative commodity enterprises; and (c) the economic role of commodity market participants.
Multi-Dimensional Risk And Performance Analysis For Equity Portfolios
2016
This paper explores a novel approach to address the challenge raised by the standard investment practice of treating attributes as factors, with respect to how to perform a consistent risk and performance analysis for equity portfolios across multiple dimensions that incorporate micro attributes. The study suggests a new dynamic meaningful approach, which consists in treating attributes of stocks as instrumental variables to estimate betas with respect to risk factors for explaining notably the cross-section of expected returns.
Hedge Fund Styles And Macroeconomic Uncertainty
2016
This paper examines the dynamic trading strategies implemented by hedge fund managers using a Kalman filter of hedge fund betas across styles. We investigate the risk drivers of dynamic trades, examining which conditioning/macroeconomic variables strongly lead time variation in fund trades. We show that hedge fund managers do control the intensity of their exposure to economic uncertainty and that differences between up- and down-market regimes can be observed.
Investor Perceptions About Smart Beta ETFs
2016
For the third year running, in view of the considerable development in new forms of indices, as well as the increasing attention smart beta ETFs have received in the media in the recent years, part of the EDHEC European ETF Survey 2015 was dedicated to investment professionals’ practices and use of products tracking smart beta indices and on the importance of risk factors in alternative equity beta strategies. The present document is a focus on investor perceptions about smart beta ETFs, as reported by the survey.
What Do Measures Of Real-Time Corporate Sales Tell Us About Earnings Surprises And Post-Announcement Returns?
2016
We develop real-time proxies of retail corporate sales from multiple sources, including ~50 million mobile devices. These measures contain information from both the earnings quarter (“within quarter”) and the period between that quarter’s end and the earnings announcement date (“post quarter”). Our within-quarter measure is powerful in explaining quarterly sales growth, revenue surprises and earnings surprises, generating average excess announcement returns of 3.4%. However, surprisingly, our post-quarter measure is negatively related to announcement returns, and positively to post-...
Initial Margin For Non-Centrally Cleared OTC Derivatives: Overview, Modelling And Calibration
2016
This paper provides a detailed overview and analysis of the forthcoming new framework to be used by large financial institutions to determine initial margin (IM) and variation margin (VM) payments when trading non-cleared over-the-counter (OTC) derivatives.
Factor Investing And Risk Allocation: From Traditional To Alternative Risk Premia Harvesting
2016
This study extends the analysis of factor investing beyond traditional factors and seeks to investigate what the best possible approach is for harvesting alternative long short-risk premia. While the replication of hedge fund factor exposure appears to be a very attractive concept, we find that hedge fund replication strategies achieve in general a relatively low out-of-sample explanatory power, regardless of the set of factors and the methodologies used. Our results also suggest that risk parity strategies applied to alternative risk factors could be a better alternative than hedge fund...
Timing Indicators for Structural Positions in Crude Oil Futures Contracts
2016
This article will argue that it is plausible that there are two fundamental metrics that could be useful for deciding upon crude oil futures positions: (1) whether there are ample inventories or not; and (2) whether spare capacity is at pinch-point levels or not. The article will further argue that a dynamic allocation strategy alone is not sufficient for holding the line against losses in a crude-oil-dominated strategy.
Swing Oil Production and the Role of Credit: A Synthesis of Best-in-Class Research Views
2016
In order to understand swing production and the role of credit, this working paper will briefly cover five topics. This working paper is based on the author’s introductory remarks and PowerPoint presentation at the International Energy Forum - Bank of Canada joint roundtable on "Commodity Cycles and Their Implications," which was held at the Bank of Canada in Ottawa on April 25th, 2016. Ms. Till participated in the concluding panel discussion on the theme, "What Will Be the New Swing Producer? The Role of Credit Conditions," which focused on the role of credit markets in the stability of the...
Ten Misconceptions about Smart Beta: Analysing common claims on performance drivers, investability issues and strategy design choices
2016
That a new investment approach be debated should not be surprising. Such debate should be expected to further the understanding of potential benefits as well as risks and possible pitfalls of the new approach. In the area of Smart Beta investing however, an intense debate has also produced a certain number of beliefs which are accepted as conventional wisdom and impede progress towards the adoption of approaches that could add more value for end investors. The objective of this paper is to provide perspective on these beliefs by examining conceptual considerations and empirical evidence.
A Primer on the Tax Framework of Offshore and Onshore Hedge Funds
2016
This paper reviews the legal and operational structures typically used by hedge funds, their managers, sponsors and investors in order to optimise their tax setup. It discusses in particular the case of U.S. domestic hedge funds set up as a limited partnership as well as the case of offshore funds based in the Cayman Islands.
A Collection of Articles on the Commodity Futures Markets, Spanning the Agricultural, Metals, and Energy Sectors
2016
This collection of four articles covers issues that are relevant to the agricultural, metals, and energy markets: The Fundamental Elements of a Commodity Investment Process, A Brief Primer on Commodity Risk Management, Why Haven’t Uranium Futures Contracts Succeeded?, and Timing Indicators for Structural Positions in Crude Oil Futures Contracts.
Commodity Risk Management
2016
This article discusses the practical issues involved in applying a disciplined risk management methodology to commodity futures trading. Accordingly, the paper shows how to apply methodologies derived from both conventional asset management and hedge fund management to futures trading. The article also discusses some of the risk management issues that are unique to leveraged futures trading.
Insights into the Frequently Opaque, and Always Dynamic, Commodity Markets
2016
This collection of four separate digest articles provides answers to the following questions: When has OPEC spare capacity mattered for oil prices?, What are the sources of return for CTAs and commodity indices?, What are the risk-management lessons from high-profile commodity derivatives debacles?, and What determines whether commodity futures contracts succeed or not?. Each article takes a different approach in answering these questions.
Portfolio Choice with Model Misspecification: A Foundation for Alpha and Beta Portfolios
2016
In this paper, our objective is to provide a rigorous foundation for alpha and beta portfolio strategies. In particular, we characterize the properties of these strategies when there is model misspecification in either the alpha component or the beta component of returns and show how to mitigate the effect of model misspecification for portfolio choice. The APT is ideal for this analysis because it allows for alphas, while still imposing no arbitrage. Our first contribution is to extend the interpretation of the APT to show that it can capture not just small pricing errors that are...
Market Efficiency And Hedge Fund Trading Strategies
2016
This paper investigates the role that hedge funds, a proxy for sophisticated investors, play in the price discovery process between stock and option markets and the disagreement/agreement periods.
Frictional Diversification Costs: Evidence from a Panel of Fund of Hedge Fund Holdings
2016
Using FoFs’ holdings data, the authors analyse the diversification choices of fund of hedge fund managers. Diversification is not a free lunch. It is not available for every fund of fund. Instead they find a positive log-linear relation between the number of constituent funds in a fund of hedge fund (n) and the respective assets under management (aum). More precisely it takes the form: n2 ∝ AuM. This relation is consistent with the predictions from a model of naive diversification (1/n) with frictional diversification costs such as due diligence costs.
The EDHEC European ETF Survey 2015
2016
The EDHEC European ETF Survey 2015, which surveyed 180 European ETF investors about their usage and perceptions of ETFs, sheds new light on drivers of investor demand for ETFs and evaluation challenges for investors. EDHEC-Risk Institute has conducted a regular ETF survey since 2006, thus providing a detailed account of the perceptions and practices of European investors in ETFs and trends over the past decade.
Term Structure Analysis Of Option Implied Volatility In The Brazilian Market Using A Continuous-Time GARCH Model
2016
This paper aims at predicting the volatility term structure of a given asset. The model is based on the GARCH modelling of the asset's volatility, from which the term structure is derived. We not only test if the model is able to predict future levels of volatility, but also if it can accommodate the term structure response to volatility shocks.
What Investment Robots Need To Know – Evidence from Panel Survey Data
2016
Automated asset management offerings, so called investment robots (or robo-advisors), assign risky portfolios to individual investors based on investor characteristics such as age, net income or self-assessments of risk aversion. Using new German household panel data, this paper investigates the key household characteristics that predict financial market participation. This information allows us to assess which set of variables is most needed to model private portfolio decisions. Using heavily cross-validated classification trees, we find that a combination of household balance sheet...
Mass Customization Versus Mass Production - How An Industrial Revolution Is About To Take Place In Investment Management And Why It Involves A Shift From Investment Products To Investment Solutions
2016
While mass production has happened a long time ago in investment management through the introduction of mutual funds and more recently exchange traded funds, a new industrial revolution is currently under way, which involves mass customization, a production and distribution technique that will allow individual investors to gain access to scalable and cost-efficient forms of goal-based investing solutions.
Does Household Finance Matter? Small Financial Errors with Large Social Costs
2016
Households with familiarity bias tilt their portfolios towards a few risky assets. Consequently, household portfolios are underdiversified and excessively volatile. To understand the implications of underdiversification for social welfare, we solve in closed form a model of a stochastic, dynamic, general-equilibrium economy with a large number of heterogeneous firms and households, who bias their investment toward a few familiar assets. We find that the direct mean-variance loss from holding an underdiversified portfolio that is excessively risky is a modest 1.66% per annum, consistent with...
How to Calibrate Risk Appetite, Tolerance and Limits: The Issues at Stake for Capital Allocation, ERM and Business Performance
2016
The Solvency II prudential framework which comes into to effect in January 2016, is likely to trigger profound changes in the insurance sector, notably i) by requiring a holistic vision of risk management, ii) coherent with risk appetite as defined in accordance with governing bodies, and iii) in line with a clearly identified governance structure. Although the Directive leaves insurance companies free to choose how they structure the risk management system and function, it does, however, require that this system be fully integrated into the organisation and the decision-making process. This...
On the Correct Evaluation of Cost of Capital for Project Valuation
2015
This paper fills a very important gap in the literature with a straightforward methodology that generalises the classic Modigliani and Miller results and provides correct values for the expected return on equity and for the weighted average cost of capital (WACC). After some confusing debate in the literature, we show that these correct values make the three main project valuation approaches (WACC, flow to equity and adjusted present value) match perfectly.
Long-Short Commodity Investing: A Review of the Literature
2015
This article reviews recent academic studies that analyse the performance of long-short strategies in commodity futures markets. Special attention is devoted to the strategies based on roll-yields, inventory levels or hedging pressure that directly arise from the theory of storage and the hedging pressure hypothesis.
Is Smart Beta Just Monkey Business? An Analysis Of Factor Exposures, Upside-Down Strategies And Rebalancing Effects
2015
“Monkey portfolio” proponents argue that all smart beta strategies generate positive value and small-cap exposure, which fully explains their outperformance. They also claim that similar results are obtained by any random portfolio strategy, including the inverse of such strategies. We analyse these claims using test portfolios which follow commonly-employed methodologies for explicit factor-tilted indices. Our results directly invalidate all of these claims.
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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.
