EDHEC Publications
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.
Skewness Strategies in Commodity Futures Markets
2015
Investors are known to display a preference for equities with positive skews (or lottery-like payoffs) and an aversion to equities with negative skews (or those for which the probability of large losses is higher than that of similar large gains). As a result, equities with positive skews tend to be overpriced and thus offer low expected returns, while equities with negative skews tend to be underpriced and thus offer high expected returns. While the pattern is well documented in the equity market literature (see, for example, Amaya et al., 2015, for some recent evidence), the question as to...
Structural Position-Taking in Crude Oil Futures Contracts
2015
Should an investor enter into long-term positions in oil futures contracts? In answering this question, this paper will cover the following three considerations: (1) the case for structural positions in crude oil futures contracts; (2) useful indicators for avoiding crash risk; and (3) financial asset diversification for downside hedging of oil price risk. This paper will conclude by noting the conditions under which one might consider including oil futures contracts in an investment portfolio.
When Has OPEC Spare Capacity Mattered for Oil Prices?
2015
Oil prices usually “feed off multiple influences”, as noted in Büyüksahin (2011). There are various influences on oil prices. However, are there times when OPEC spare capacity is the most important factor for driving oil prices? This article will argue the answer is yes, and will discuss the circumstances when this has been the case in the past.
The Limitations Of Factor Investing: Impact Of The Volkswagen Scandal On Concentrated Versus Diversified Factor Indices
2015
Volkswagen has been caught up in one of the most notorious scandals in corporate history by installing cheat software to reduce emissions during testing. The news broke on the eve of Friday, 18 September 2015 and the stock markets heavily penalised Volkswagen AG and other automobile stocks, including suppliers, on Monday, 21 September 2015.
What are the Sources of Return for CTAs and Commodity Indices? A Brief Survey of Relevant Research
2015
This survey paper will discuss the (potential) structural sources of return for both CTAs and commodity indices based on a review of empirical research articles from both academics and practitioners. The paper specifically covers (a) the long-term return sources for both managed futures programs and for commodity indices; (b) the investor expectations and the portfolio context for futures strategies; and (c) how to benchmark these strategies. A revisited version of this paper was published in the Winter 2016 issue of the Journal of Wealth Management.
Commodities as Lotteries: Skewness and the Returns of Commodity Futures
2015
This article studies the relation between skewness and subsequent returns in commodity futures markets. Systematically buying commodities with low skewness and shorting commodities with high skewness generates a significant excess return of 8% a year, which is not merely a compensation for the risks associated with backwardation and contango. Skewness is also found to explain the cross-section of commodity futures returns beyond exposures to the backwardation and contango risk factors previously identified.
Stock Market Dispersion, the Business Cycle and Expected Factor Returns
2015
This paper provides evidence using data from the G7 countries suggesting that return dispersion may serve as an economic state variable in that it reliably predicts time-variation in economic activity, market returns, the value and momentum premia and market volatility. A relatively high return dispersion predicts a deterioration in business conditions, a higher value premium, a smaller momentum premium and lower market returns. The evidence is robust to alternative specifications of return dispersion and is not driven by US data. Return dispersion conveys incremental information relative to...
Factor Investing: A Welfare-Improving New Investment Paradigm or Yet Another Marketing Fad?
2015
This paper examines the relative efficiency of standard forms of practical implementation of the factor investing paradigm based on commonly-used factors in the equity, fixed-income and commodity universes. Investment practice has recently witnessed the emergence of a new approach known as factor investing, which recommends that allocation decisions be expressed in terms of risk factors, as opposed to standard asset class decompositions. To answer the question of whether factor investing is truly a welfare-improving new investment paradigm or whether it is merely yet another marketing fad,...
Commodity Markets, Long-Run Predictability and Intertemporal Pricing
2015
This paper shows that backwardation versus contango factor-mimicking portfolios exhibit in-sample and out-of-sample predictive power for the first two moments of the distribution of long-run aggregate market returns and for the business cycle. It also demonstrates that a pricing model based on innovations to the backwardation versus contango risk factors explains relatively well a wide cross-section of equity portfolios. The cross-sectional “hedging” risk prices are economically consistent with the direction of long-run predictability of expected market returns and variances. Backwardation...
Commodity Risks and the Cross-Section of Equity Returns
2015
The article examines whether commodity risk is priced in the cross-section of global equity returns. We employ a long-only equally-weighted portfolio of commodity futures and a term structure portfolio that captures phases of backwardation and contango as mimicking portfolios for commodity risk. We find that equity-sorted portfolios with greater sensitivities to the excess returns of the backwardation and contango portfolio command higher average excess returns, suggesting that when measured appropriately, commodity risk is pervasive in stocks. Our conclusions are robust to the addition to...
Active Allocation To Smart Factor Indices
2015
This paper provides a formal empirical analysis of the benefits of strategic and tactical allocation to multiple equity smart factor indices in a context where relative risk with respect to the cap-weighted indices needs to be explicitly controlled for. The focus of this paper is to provide a quantitative assessment of the benefits expected from the three sources of added-value (which come from time-varying strategic, time-varying tactical or time-varying core-satellite allocation decisions) in the design of equity benchmarks with superior risk and return characteristics.
The Valuation of Privately-Held Infrastructure Equity Investments: Theoretical Framework and Data Collection Requirements
2015
This paper proposes a valuation framework for privately-held and very illiquid assets such as equity stakes in infrastructure projects. Such a framework is one of the key steps identified by EDHEC-Risk Institute as part of a roadmap to design long-term infrastructure investment benchmarks that can take into account the nature of such assets as well as the paucity of available data.
Investor Interest In And Requirements For Smart Beta ETFs
2015
Exchange-traded funds (ETFs) are perhaps one of the greatest financial innovations of recent years. Unlike conventional index funds, ETF units trade on stock exchanges at market-determined prices, thereby combining the advantages of mutual funds and common stocks. Most of them represent passive instruments designed to track the performance of a financial index as closely as possible. Recently, the standard practice of using a capitalisation-weighting scheme for the construction of indices has been the target of harsh criticism. Nowadays, growing demand for indices as investment vehicles has...
The EDHEC European ETF Survey 2014
2015
EDHEC Risk Institute conducted its 8th survey of European investment professionals about the usage and perceptions of ETFs at the end of 2014. The aim of this study is to analyse the usage of exchange-traded funds (ETFs) in investment management and to give a detailed account of the current perceptions and practices of European investors in ETFs.
Alternative Equity Beta Investing: A Survey
2015
Alternative equity beta investing has attracted increased attention within the industry recently. Though products in this segment currently represent only a fraction of overall assets, there has been tremendous growth recently in terms of both assets under management and new product development. In this context, EDHEC-Risk recently carried out a survey among a representative sample of investment professionals to identify their views and uses of alternative equity beta.
Accounting For Geographic Exposure In Performance And Risk Reporting For Equity Portfolios
2015
A standard practice in reporting geographic exposure of equity portfolios is to report breakdown of portfolio constituents by country or region, which are assigned to a stock based on its place of listing, incorporation or headquarters. However, the practice is questionable in the context of a globalised marketplace where a company's operations are usually not restricted to any single country (or region).
Introducing A Comprehensive Investment Framework For Goals-Based Wealth Management
2015
Any investment process should start with a thorough understanding of the investor problem. Individual investors do not need investment products with alleged superior performance; they need investment solutions that can help them meet their goals subject to prevailing dollar and risk budget constraints. This paper develops a general operational framework that can be used by financial advisors to allow individual investors to optimally allocate to categories of risks they face across all life stages and wealth segments so as to achieve personally meaningful financial goals.
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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.
