THIRD-PARTY RESEARCH

To access the articles below, first make sure you are logged in as a member, and then click the links below. Membership is free, click here to register.

• Skill, Luck and the Multi-Product Firm:
  Evidence from Hedge Funds
  
  
  We propose that higher skilled firms diversify in equilibrium even though managers exploit idiosyncratic performance shocks to time diversification moves. We formalize this intuition in a mistakefree equilibrium and test our predictions using a large panel dataset on the hedge fund industry 1977- 2006. The results show that returns fall following new fund launches, but are 13 basis points per month higher in diversified firms compared to a matched control sample of focused firms. Consistent with the theory, the evidence suggests that both idiosyncratic performance shocks and systematic differences in skill influence diversification decisions. Click here for full article
  Rui J.P. de Figueiredo, Jr., University of California, Berkeley
  Evan Rawley, University of Pennsylvania
  
• Crowded Chickens Farm Fewer Eggs -
  Capacity Constraints in the Hedge Fund Industry Revisited
  
  
  We revisit the question of capacity constraints in the hedge fund industry by looking at over 2,000 individual funds operating within ten different strategy segments over the years 1994 to 2006. By first looking at fund specific determinants of alpha returns, we demonstrate that the negative effect of inflows on performance is dominated by a concave size effect and thus nonlinear. Secondly, we investigate how competitive dynamics within a strategy segment influence alpha returns. The finding of a concave relationship between the total size of a segment and individual fund performance supports the notion of limiting capacity constraints on strategy level. While fund specific determinants only apply to funds that generated alpha in the past, strategy segment effects apply to all funds. Click here for full article
  Oliver Weidenmüller and Marno Verbeek
  Rotterdam School of Management, Erasmus University
  
• The Good, the Bad or the Expensive? Which Mutual Fund Managers
  Join Hedge Funds?
  
  
  Does the mutual fund industry lose its best managers to hedge funds? We find that a mutual fund manager with superior past performance is more likely to start managing an in-house hedge fund while continuing to manage mutual funds. However, a mutual fund manager with poor past performance is more likely to leave the mutual fund industry to manage a hedge fund. Thus, mutual funds appear to use in-house hedge funds to retain the best-performing managers in the face of competition from hedge funds. In addition, the managers of mutual funds with greater expenses are more likely to enter the hedge fund industry. The magnitude of such expenses is negatively related to subsequent performance in the hedge fund industry. Hence, hedge funds do not acquire superior performance for their investors by hiring these expensive managers. Click here for full article
  Prachi Deuskar, University of Illinois at Urbana
  Joshua M. Pollet, Goizueta Business School, Emory University
  Z. Jay Wang, University of Illinois at Urbana
  Lu Zheng, Paul Merage School of Business, University of California Irvine
  
• Performance Bias from Strategic Asset Allocation:
  The Case of Funds of Hedge Funds
  
  
  Evaluating the performance of portfolio managers has received wide attention in the finance literature. The common practice is to divide performance, which is attributable to active management, into two main components, security selection and market timing. However, the Brinson et al. studies and the controversial debate on the relative importance of asset allocation and security selection reveal that the strategic asset allocation has a significant impact on the performance of an actively managed portfolio. Nevertheless, up to now neither an empirical study has taken that portfolio decisions into account in the performance evaluation nor has anyone previously discussed a possible performance bias which could arise from the strategic asset allocation decisions. Beside its direct influence on the performance of funds of hedge funds, the strategic asset allocation induces a performance bias similar to the timing bias, which results from actively changing the beta of the portfolio of hedge funds by the portfolio manager. Unfortunately, normally the historical portfolio holdings of funds of hedge funds are not available due to their low transparency. In order to estimate the strategic asset allocation of each fund of hedge funds we use Sharpe’s [1988, 1992] returns-based style analysis (RBSA), which requires only the monthly performance. By comparing the selectivity and timing performance of 2638 funds of hedge funds, 2095 live funds and 543 dead funds, estimated with Jensen’s [1968] model and the timing model of Treynor and Mazuy [1966] using fund specific benchmark portfolios – which reflect the funds’ strategic asset allocations – against the selectivity and timing performance estimates generated with traditional hedge fund and fund of hedge funds indices, we document a performance bias which is clearly induced by the strategic asset allocation decision. This bias causes an overestimation of the true selectivity and timing performance of funds of hedge funds. In order to avoid these biases, both academics and practitioners should evaluate the performance of funds of hedge funds against benchmark portfolios which reflect the fund specific strategic asset allocation. Over the period from 1994 - 2006, we find that funds of hedge funds exhibit a negative monthly selectivity performance of -0.1648 and a monthly timing performance of -0.0263. Click here for full article
  Dr. Oliver A. Schwindler, Department of Finance, Bamberg University
  
• Lintner Revisited:
  The Benefits of Managed Futures 25 Years Later
  
  
  In this paper we attempt to update Professor Lintner’s work by demonstrating that the beneficial correlative properties of managed futures presented in his research persist today. Click here for full article
  Ryan Abrams, AlphaMetrix Alternative Investment Advisors, LLC
  Ranjan Bhaduri, AlphaMetrix Alternative Investment Advisors, LLC
  Elizabeth Flores, CME Group
  
• Selectivity and Timing Performance of Funds of Hedge Funds:
  A Time-Varying Approach
  
  
  This paper empirically examines the time variation of the selectivity and timing performance of funds of hedge funds by employing rolling versions of the performance regression models of Jensen (1968) and Treynor and Mazuy (1966). The analysis is based on a sample of 1,207 funds of hedge funds during January 1994 until December 2006. We propose for the first time a cross-sectional regression method similar to those used by Fama and McBeth (1973) for the analysis of the determinants of the performance of funds of hedge funds. Moreover, we use fund specific style benchmarks, which reflect the performance of the individual strategic asset allocation decision of each fund. Our results show that positive selectivity performance has faded away over the sample period and has become negative in recent years while the timing performance erratically fluctuates around zero. The cross-sectional regression reveals that the importance of the selectivity and timing seems to rotate over time, as both variables show considerable variation over time and different magnitudes in the cross-section. Summing up, we present profound and robust evidence that selectivity performance can be regarded as a good discriminating factor for superior funds of hedge funds. Click here for full article
  Dr. Marco Rummer, Saïd Business School, Oxford University
  Dr. Oliver A. Schwindler, Department of Finance, Bamberg University
  
• Recovering Delisting Returns of Hedge Funds
  
  
  Numerous hedge funds stop reporting to commercial databases each year. An issue for hedgefund performance estimation is: what delisting return to attribute to such funds? This would be particularly problematic if delisting returns are typically very different from continuing funds’ returns. In this paper, we use estimated portfolio holdings for funds-of-funds with reported returns to back out maximum likelihood estimates for hedge-fund delisting returns. The estimated mean delisting return for all exiting funds is small, although statistically significantly different from the average observed returns for all reporting hedge funds. These findings are robust to relaxing several underlying assumptions. Click here for full article
  James E. Hodder, Professor - Finance, University of Wisconsin-Madison
  Dr. Jens Jackwerth, Head Dept of Economics, University of Konstanz
  Olga Kolokolova, Research Asst., University of Konstanz
  
• The Impact of Hedge Fund Family Membership on Performance and Market Share
  
  
  We study the impact that hedge fund family membership has on performance and market share. Hedge funds from small fund families outperform those from large families by a statistically significant 4.4% per year on a risk-adjusted basis. We investigate the possible causes for this outperformance, and find that regardless of family size, fund families that focus on their core competencies have “core competency” funds with superior performance, while the family’s non-core competency funds underperform. We next examine the determinants of hedge fund family market share. A family’s market share is positively related to the number and diversity of funds offered, and is also positively related to past fund performance. Finally, we examine the determinants of fund family market share at the fund style/strategy level. Families that focus on their core competencies attract positive and significant market share to these core-competency funds. Hence, by starting new funds only in their family’s core competencies, fund managers can enjoy increased market share while their investors enjoy good performance. Click here for full article
  Nicole M. Boyson, Asst. Professor of Finance, Northeastern University
  
• How Successful is the G7 in Managing Exchange Rates?
  
  
  The paper assesses the extent to which the Group of Seven (G7) has been successful in its management of major currencies since the 1970s. Using an event-study approach, the paper finds evidence that the G7 has been overall effective in moving the US dollar, yen and euro in the intended direction at horizons of up to three months after G7 meetings, but not at longer horizons. While the success of the G7 is partly dependent on the market environment, it is also to a significant degree endogenous to the policy process itself. The findings indicate that the reputation and credibility of the G7, as well as its ability to form and communicate a consensus among individual G7 members, are important determinants for the G7’s ability to manage major currencies. The paper concludes by analyzing the factors that help the G7 build reputation and consensus, and by discussing the implications for global economic governance. Click here for full article
  Marcel Fratzscher, Senior Adviser, European Central Bank-Frankfurt
  
• The Performance of Funds of Hedge Funds: Do Experience and Size Matter?
  
  
  This paper is the first to use quantile regression to analyze the impact of experience and size of funds of hedge funds (FHFs) on performance. In comparison to OLS regression, quantile regression provides a more detailed picture of the influence of size and experience on FHF return behaviour. Hence, it allows us to study the relevance of these factors for various return and risk levels instead of average return and risk, as is the case with OLS regression. Because FHF size and age (as a proxy for experience) are available in a panel setting, we can perform estimations in an unbalanced stacked panel framework. This study analyzes time series and descriptive variables of 649 FHFs drawn from the Lipper TASS Hedge Fund database for the time period January 1996 to August 2007. Our empirical results suggest that experience and size have a negative effect on performance, with a positive curvature at the higher quantiles. At the lower quantiles, however, size has a positive effect with a negative curvature. Both factors show no significant effect at the median. Click here for full article
  Roland Füss, International University Schloss Reichartshausen
  Dieter G. Kaiser, Feri Institutional Advisors GmbH
  Anthony Strittmatter, University of Freiburg
  
• Trades of the Living Dead: Style Differences, Style Persistence and Performance of Currency Fund Managers
  
  
  We make use of a new database on daily currency fund manager returns over a threeyear period, 2005-08. This higher frequency data allows us to estimate both alpha measures of performance and beta style factors on a yearly basis, which in turn allows us to test for persistence. We find no evidence to support alpha persistence; a manager’s alpha in one year is not significantly related to his alpha in the prior year. On the other hand, there is substantial evidence for style persistence; funds that rely on carry, trend or value trading or with a long/short bias toward currency volatility are likely to maintain that style in the following year. In addition, we are able to examine the performance of managers that survive through the entire sample period, versus those that drop out. We find significant differences in both the investment styles of living versus deceased funds, as well as their realized alpha performance measures. We conjecture that both style differences and ineffective market timing, rather than market conditions, have impacted performance outcomes and induced some managers to close their funds. Click here for full article
  Momtchil Pojarliev, Hermes Investment Management Limited
  Richard M. Levich, New York University's Leonard N. Stern School of Business
  
• The Rising Costs of Low U.S. Interest Rates
  
  
  The Federal Open Market Committee’s (FOMC) decision to drastically reduce interest rates over the past year may be viewed positively in hindsight because it prevented a collapse of the U.S. credit markets. But it is more likely that this decision will be remembered for the toll it exacted on the U.S. economy and global markets. After tightening monetary policy for two years, from June 2004 to June 2006, the decision by the FOMC in the autumn of last year to reverse course seems to have provided some short-term relief to U.S. financial institutions and credit markets. But it also has significantly raised the long-term costs and challenges of restoring price stability in the consumer goods and financial markets. Click here for full article
  Ryan Faulkner, President, Faulkner Capital Inc.
  
• Credit Risk Transfer, Hedge Funds, and the Supply of Liquidity
  
  
  This paper provides a discussion about some recent issues related to the transfer of credit risk (CRT) from the perspective of global liquidity. The CRT market is enormously growing and exhibits major structural shifts in terms of buyers and sellers of protection. I try to address these issues from an options perspective by suggesting that liquidity providing can be understood, in economic terms, as selling put options. The overall conclusion of the paper is that it is not the extent of CRT per se, as often claimed, which causes liquidity related systemic risk, but rather the potential coordination failures of the behavior market participants in adverse market environments. In this context, I critically address the role of investments banks in providing liquidity to hedge funds, and finally, the (limited) access of global banks to central bank liquidity through cross-border collateral trading. Since coordination failures, seen as the major issue of a potential liquidity crisis, is to a large extent a matter of market structure, regulatory actions to improve liquidity should focus on the architecture of the financial system in the first place, not so much on the behavior of individual agents. Market stabilization should therefore be understood as a process of establishing informative markets and adequate infrastructure. Click here for full article
  Heinz Zimmermann, University of Basel, Switzerland
  
• Crisis and Hedge Fund Risk
  
  
  We study the effect of financial crises on hedge fund risk. Using a regime-switching beta model, we separate systematic and idiosyncratic components of hedge fund exposure. The systematic exposure to various risk factors is conditional on market volatility conditions. We find that in the high-volatility regime (when the market is rolling-down and is likely to be in a crisis state) most strategies are negatively and significantly exposed to the Large-Small and Credit Spread risk factors. This suggests that liquidity risk and credit risk are potentially common factors for different hedge fund strategies in the down-state of the market, when volatility is high and returns are very low. We further explore the possibility that all hedge fund strategies exhibit a high volatility regime of the idiosyncratic risk, which could be attributed to contagion among hedge fund strategies. In our sample this event happened only during the Long-Term Capital Management (LTCM) crisis of 1998. Other crises including the recent subprime mortgage crisis affected hedge funds only through systematic risk factors, and did not cause contagion among hedge funds. Click here for full article
  Monica Billio, University of Venice - Department of Economics
  Mila Getmansky, University of Massachusetts at Amherst
  Loriana Pelizzon, University of Venice - Department of Economics
  
• A Portrait of Hedge Fund Investors: Flows, Performance and Smart Money
  
  
  We explore the flow-performance interrelation of hedge funds by separating the investment and divestment decisions of investors. We report three main results. First, we find a weak inflow-performance relation at quarterly horizons together with a very steep outflow-performance relation. At annual horizons, these patterns revert. We attribute this differential response time of inflows and outflows to the combined effect of liquidity restrictions, high searching costs and active investors' monitoring. Second, consistent with the theory that performance persistence is more pronounced where money flows are the least responsive, we find remarkable differences in persistence levels across horizons for the subsets of funds experiencing inflows and outflows. Third, we show that investors' limited response capacity precludes them from investing into the subsequent good performers. Conversely, investors appear to be fast and successful in de-allocating from the subsequent poor performers. Click here for full article
  G. Baquer, ESMT European School of Management and Technology
  Marno Verbeek, Rotterdam School of Management, Erasmus University
  
• Time Frames, Research Quality and Strategy: The Differentiating Factors for CTAs?
  
  
  Studies dealing with the classification of CTAs have not effectively examined the distinction between the time frame these managers trade and the strategies they employ. Nor have such studies examined the information that rigorous due diligence adds to the process of classifying CTA s. This paper utilizes a set of CTA managers screened from the Barclay CTA (Managed Futures) Data Feeder database. Returns of these managers are analyzed using variables in this database as well as information collected in an extensive due diligence review. The results suggest that time frame and strategy are distinct factors in the classification of CTA managers. Furthermore, with ratings derived from the due diligence review, research quality is identified as a separate factor affecting CTA returns. Click here for full article
  Elliot Noma, Amal Alibair, and William T. Long
  Asset Alliance Corporation
  
• Do Professional Currency Managers Beat the Benchmark?
  
  
  We investigate an index of returns on professionally managed currency funds and a subset of returns from 34 individual currency fund managers. Over the period 1990-2006, excess returns earned by currency fund managers have averaged 25 basis points per month. We examine the relationship of these returns to four factors representing returns based on carry trading, trend-following, value trading and currency volatility. These four factors explain a substantial portion of the variability in index returns in the entire period and in sub-periods. We perform similar regressions for the 34 individual funds, and find many funds where returns are significantly related to these four factors. Our approach impacts the definition of alpha returns from currency speculation, modifying it from the excess return earned by the fund, to only that portion of the excess returns not explained by the four factors. While the impact on measured alpha is substantial, we find that some currency fund managers continued to generate alpha returns in the most recent sample period. Click here for full article
  Momtchil Pojarliev, Hermes Investment Management Limited
  Richard M. Levich, New York University Stern School of Business
  
• Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures
  
  
  This paper investigates potential sources of return to speculators in the commodity futures market. Initially, we focus on the classic arbitrage model based on the theories of Keynes (1930), Kaldor (1939), Hicks (1939, 1946), Working (1948) and Brennan (1958). Next our study examines the simplified arbitrage model which references the term structure of the futures price curve and provides rationale for a structural risk premium known as the roll return. We then introduce our theory of roll yield permutations which is derived from integrating the futures price curve with the expected future spot price variable. Last, we investigate Spurgin's (2000) hedging response model from which asymmetric hedging response functions transfer risk premia to speculators.
  Our research indicates that these models have inherent shortcomings in being able to pinpoint a definitive source of structural risk premium within the complexity of the commodity futures markets. We hypothesize that the classic arbitrage pricing theory contains circular logic, and as a consequence, its natural state is disequilibrium, not equilibrium. We extend this hypothesis to suggest that the term structure of the futures price curve, while indicative of a potential roll return benefit, in fact implies a complex series of roll yield permutations. Similarly, the hedging response function elicits a behavioral risk management mechanisms, and therefore, corroborates social reflexivity. Such models are inter-related and each reflects certain qualities and dynamics within the overall futures market paradigm.
  With respect to managed futures, it is an observable materialization of behavioral finance, where risk, return, leverage and skill operate un-tethered from the anchor of an accurate representation of beta. In other words, it defies rational expectations equilibrium, the efficient market hypothesis and allied models - the CAPM, arbitrage pricing theory or otherwise - to single-handedly isolate a persistent source of return without that source eventually slipping away. Click here for full article
  Davide Accomazzo, Adjunct Professor of Finance, Pepperdine University
  Michael Frankfurter, Managed Account Research, Inc.
  Principals, Cervino Capital Management, LLC
  
• What Happened to the Quants In August 2007?
  
  
  During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. Based on TASS hedge-fund data and simulations of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid unwind of one or more sizable quantitative equity market-neutral portfolios. Given the speed and price impact with which this occurred, it was likely the result of a forced liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to a margin call or a risk reduction. These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses by triggering stop/loss and de-leveraging policies. A significant rebound of these strategies occurred on August 10th, which is also consistent with the unwind hypothesis. This dislocation was apparently caused by forces outside the long/short equity sector in a completely unrelated set of markets and instruments suggesting that systemic risk in the hedge-fund industry may have increased in recent years. Click here for full article
  Andrew W. Lo, Harris & Harris Group
  Amir E. Khandani, MIT Laboratory for Financial Engineering
  
• Conducting Investment Due Diligence on Active Natural-Resource Managers
  
  
  Natural-resource managers make or lose their bread-and-butter by structuring active bets in the commodity markets in a variety of ways. Active managers may try to call the market direction correctly; make relative-value bets in the derivatives markets; take on basis risk; invest in natural-resources equities, particularly in emerging markets; or they may trade physical commodities. Active natural-resource managers need to be clearly differentiated from Commodity Trading Advisors (CTA’s) and index funds. CTA’s (or systematic trend followers) exploit trends in the financial and commodity markets. Indexed commodity funds, in turn, offer the investor pure commodity exposure. The case for institutional investors to include both passive commodities portfolio exposure as well as active commodities management has been made by a variety of industry observers. Until now, however, the subset of active natural-resource managers has not seen the growth in assets that the commodity index funds have seen. Clearly, active natural-resource investing is not nearly as well understood by institutional investors. As such, an institutional investor considering an investment with a naturalresources manager needs to understand the trading strategies, risks, and potential returns in this investment category. This article will focus on the due-diligence process as it applies to investment strategies commonly used by active natural-resource managers. Click here for full article
  John E. Dunn, III, Oak Point Investments
  
• FUNDCREATOR - Reply to the Critics
  
  
  Since the publication of our first paper on hedge fund replication in 2005, our FundCreator methodology has met with many positive reactions. There have also been some negative responses though. Until now we have not responded to the criticism launched against FundCreator, other than the occasional remark when asked for comments. However, with a number of high profile conferences on the subject coming up this year and early next year and investors clearly becoming confused as a result of the amount of disinformation that is being circulated, in this short paper we will address the 10 most common points of criticism. We will argue that most of these are largely unjustified and fairly trivial at best and no reason whatsoever to doubt the capability of FundCreator to deliver exactly what it promises: returns with predefined statistical properties. Here we go. Click here for full article
  Harry M. Kat and Helder P. Palaro
  Cass Business School
• Is There Hedge Fund Contagion?
  
  
  We examine whether hedge funds are more likely to experience extremely poor returns when equity, fixed income, and currency markets or other hedge funds have extremely poor performance than would be predicted by correlations of hedge fund returns with returns on these markets or with returns of other hedge funds (contagion). First, we consider whether extreme movements in these markets are contagious to Arbitrage, Directional, and Event Driven hedge fund indices. Second, we investigate whether extreme adverse returns in one hedge fund index are contagious to other hedge fund indices. To conduct these examinations, we estimate Poisson regressions using both monthly and daily returns on hedge fund style indices. We find no systematic evidence of contagion from equity, fixed income, and currency markets to hedge fund indices, although the Arbitrage index exhibits evidence of contagion from the equity and currency markets for monthly data. In contrast, we find systematic evidence of contagion across hedge fund styles for both monthly and daily data. Our results provide a new perspective on the systemic risks of hedge funds and suggest that diversification across hedge funds may not help as much as correlations would imply in reducing the probability of very poor returns. Click here for full article
  Nicole M Boyson, Northeastern University
  Christof W. Stahel, George Mason University
  René M. Stulz, Ohio State University
• A Subprimer on Risk
  
  
  Early in 2007, there were concerns about two issues that could wind up causing significant havoc. One was the potential unwind of the yen carry trade, which we covered in our last issue. The other was the weakness in subprime mortgages in the US. At the risk of further cursing the market, it is fair to say that the yen carry trade scenario has not come about as yet. But clearly, the subprime issue has come to a head, and by now has impacted markets directly linked to subprime, such as securitized products and the equity of mortgage lenders, and others where the link is at best indirect, such as corporate credit, leveraged buyouts, and global equities. A postmortem analysis of these market events is premature, since the situation is still quite fluid. A comprehensive analysis of subprime mortgages, the catalyst of our current excitement, is beyond the scope of our efforts here. Still, it is not a market we can ignore, and so we offer some thoughts here on what is particular about subprime, and what we might be able to learn after this storm has blown over. Click here for full article
  Christopher C. Finger, RiskMetrics Group
• Trading Strategies in the Current Commodity Market Environment
  
  
  When I recently co-edited the book, “Intelligent Commodity Investing” (Risk Books, 2007), a risk-management professional asked me if the title of the book is an oxymoron. This question was posed soon after the Amaranth debacle so perhaps the question is an appropriate one. This article will argue that one can indeed intelligently invest in the commodity markets and will briefly touch on three approaches, which in turn are drawn from the “Intelligent Commodity Investing” book. The first two sections of this article will discuss two historically profitable approaches that take into consideration the largely mean-reverting properties of commodity prices. The final section of the article will argue that we are in the midst of a rare trend shift in prices for some commodity markets and will provide some ideas on how to benefit from this shift. Click here for full article
  Hillary Till, Principal, Premia Capital Management, LLC
• "Carried Away?"
  
  
  Dubbed the “Trade of the Decade” by at least one website, it is difficult to imagine a single trading strategy getting more popular attention than the carry trade has over the last eighteen months. Headlines in early 2006 included “Japan’s Boom May Explode Yen-Carry Trade” and “Yen Carry Trade to Unwind—Market Crash Alert”. Fears rose again in early 2007: in “What keeps bankers awake at night?” the Economist made the carry trade first on its list. But the fears seem to have subsided, with the Economist acknowledging more recently that the carry trade may have gone “Out With a Whimper.” Click here for full article
  Christopher C. Finger, RiskMetrics Group
• Survey of Recent Hedge Fund Articles
  
  
  In this article, we provide the busy reader with a survey of articles that were written over the past four years on hedge funds. Specifically, we review the economic basis for hedge fund returns and then discuss some of the logical consequences of these observations. Next, we summarize the general statistical properties of hedge fund strategies. We then examine what the appropriate performance measurement and risk management techniques are for these investments. And lastly, we briefly cover ways that investors can consider incorporating hedge funds within their overall portfolios. Click here for full article
  Hilary Till, Premia Risk Consultancy, LLC
• Hedge Funds: Myths & Facts
  
  
  Never has an industry so extensively studied by “experts” produced such a surplus of myths, misunderstandings, and half-truths. Many of these myths could easily be clarified with a call or two to knowledgeable industry professionals. Too often, a seemingly logical statement that sounds-good-when-you-say-it-fast becomes accepted conventional wisdom despite the reams of evidence weighted against it. Although many of these experts are well-intentioned, they may not be sufficiently well-informed. The solution lies in enhanced collaboration between academia, industry, and the press. Click here for full article
  Ed Easterling, Crestmont Research
• Performance in the Currency Industry - Is the End Nigh?
  
  
  The interest in commodity trading advisers (CTAs) and hedge funds trading purely currency has increased significantly in recent times; this has both been with respect to the number of participants involved and the money-under-management allocated to the sector, Middleton (2006). Performance has suffered over the past couple of years and this has led many to question how sustainable this popularity in currency will be.
  The purpose of this paper is to investigate the downturn in performance experienced by currency programmes over the past couple of years. Active currency indices are used, together with transparent proxies for style, to highlight the importance of assessing performance over as long a period as possible prior to making investment decisions. The paper puts forward some possible explanations for the recent difficulties; investigates whether the investor’s appetite for currency as an asset class still remains; and concludes with thoughts on the ways in which participants may have to change in order to adapt to the new environment. Click here for full article
  Amy Middleton, Bank of America
• Replication - Based Evaluation of Hedge Fund Performance
  
  
  In this paper we use the hedge fund return replication technique recently introduced in Kat and Palaro (2005) to evaluate the net-of-fee performance of 875 funds of hedge funds and 2073 individual hedge funds, up to an including November 2006. Comparing fund returns with the returns on dynamic futures trading strategies with the same risk and dependence characteristics, we find that no more than 18.6% of the funds of funds and 22.5% of the individual hedge funds in our sample convincingly beat the benchmark. In other words, the majority of hedge funds have not provided their investors with returns, which they could not have generated themselves by mechanically trading a diversified basket of liquid futures contracts. Over time, we observe a substantial deterioration in overall hedge fund performance. In addition, we find a tendency for the performance of successful funds to deteriorate over time. This supports the hypothesis that increased assets under management tend to endanger future performance. Click here for full article
  Harry M. Kat, Cass Business School
• Exploring Value in Hedge Fund Lock Ups: A Sector View
  
  
  One of the more notable trends in the hedge fund industry over the past few years is the migration toward more stringent liquidity terms. That is, managers are requiring lock ups of one year or longer and are also lengthening notice periods for redemptions. Numerous reasons exist for this shift including potential SEC registration that may be skirted by employing a lock up of two years or more, a trend toward lesser-liquid underlying investments in an attempt to generate favorable returns and, for lack of a better term, manager greed. The SEC regulation rationale appears moot for the time being given that the mandatory registration requirement has been indefinitely tabled (see Goldstein, et al v. SEC, 2006). The most legitimate argument appears to be the utilization of more strict liquidity terms in order to better match fund assets and liabilities as managers migrate toward lesser-liquid underlying investments. Manager greed on the other hand continues to exemplify a straight forward supply and demand issue: the highest quality managers with the best performance are likely to be more in demand and will best be in a position to dictate lock up requirements.
  Notwithstanding the aforementioned arguments, the question remains as to what longterm value is being added by managers employing more inflexible liquidity terms. In this study we revisit, albeit with a different set of data, the observations of Liang (1999) pertaining to fund lock ups and performance. We then delve further into the data on a sub-strategy basis to determine the extent of value added and to discuss the necessity of lock ups given the nature of the underlying securities employed within each sub-strategy. Click here for full article
  Jeffrey F. Kuchta, CFA
  
• Superstars Versus Teamwork
  
  
  One of the most powerful tensions in the world of money management is in the pull between assets that perform well on their own and portfolios that perform well. Even the most casual students of finance know about the importance of diversification. But as soon as any one asset turns in a bad performance, the temptation to dump that asset and replace it with something that performed better is nearly irresistible. What we found in this research is that team players outperformed superstars. We found that the difference was statistically significant. We found that in most cases replacing “underperforming” managers with someone who would have been better did little or nothing to improve overall portfolio performance. We did find, though, that firing team players for poor individual performance and replacing them with managers with higher Sharpe ratios seriously degraded the performance of the portfolio. Click here for full article
  Galen Burghardt, Ryan Duncan, Lianyan Liu
  Calyon Financial
  
• EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle
  
  
  We examine how Amaranth, a respected, diversified multi-strategy hedge fund, could have lost 65% of its $9.2 billion assets in a little over a week. To do so, we take the publicly reported information on the fund’s Natural Gas positions as well as its recent gains and losses to infer the sizing of the fund’s energy strategies. We find that as of the end of August, the fund’s likely daily volatility due to energy trading was about 2%. The fund’s losses on 9/15/06 were likely a 9-standard-devation event. We discuss how the fund’s strategies were economically defensible in providing liquidity to physical Natural Gas producers and merchants, but find that like Long Term Capital Management, the magnitude of Amaranth’s energy position-taking was inappropriate relative to its capital base. Click here for full article
  Hilary Till, EDHEC Risk and Asset Management Research Centre
  and Principal, Premia Capital Management, LLC
  
• Is The Case For Investing In Commodities Really That Obvious?
  
  
  Although commodity markets have been around for centuries, investors? interest in them has always been quite limited. Over the last few years, however, this has changed completely. Commodities have very quickly become very popular and investment in commodities is growing at an unprecedented rate. It is estimated that over the past few years (institutional) investors have poured $75 billion into commodities and according to a recent institutional investor survey by Barclays Capital, many institutions expect to significantly increase their commodity exposure further over the next three years1. After initially taking a somewhat reserved view on the commodity investment boom, the supply side is rolling out a whole range of commodity-linked products; funds, ETFs, trackers, and all kinds of structured products. Given investors? appetite for and the very healthy profit margins earned on these products, the end of the boom may not be in sight yet. Click here for full article
  Harry M. Kat, Cass Business School
  
• Early Reporting Effects on Hedge Fund and CTA Returns
  
  
  New research by CISDM and the Barclay Group examines the early reporting habits of hedge funds and CTAs. In the article, “Early Reporting Effects on Hedge Fund and CTA Returns,” published in the Journal of Alternative Investments, Fall 2006 issue, it is shown that hedge funds and to a lesser extent CTAs who delay reporting returns often report lower performance than those who report early. Hedge fund and CTA indices published by the Barclay Group are used to demonstrate the differences between early estimates and final numbers. Each month, Barclay’s provides an early estimate (usually within the first week of the month) of the previous month’s returns by strategy based on reporting managers. Typically within weeks following the early estimate, Barclay’s provides a final estimate for the previous month’s hedge fund and/or CTA index returns.
  Note that hedge fund and CTA fund/manager returns are reported in the month following the actual month of performance. This provides enough time for firms to properly calculate returns using various administrative reporting services and report them (if desired) to several of the existing hedge fund databases. The Barclay group is one of several firms or organizations currently reporting hedge fund and CTA returns on the industry. Other major hedge fund and CTA index reporting organizations include CISDM and HFR. While some overlap exists among databases managed by various firms and organizations, past research (Jones, 2005) has shown that each database differs as to reporting managers (approximately 50%). Click here for full article
  Thomas Schneeweis, Richard Spurgin, and Sol Waksman
  
• What Every Investor Should Know About Commodities. Part II: Multivariate Return Analysis
  
  
  In this paper we study the multivariate return properties of a large variety of commodity futures. We find that between commodity groupings (such as metals, energy, etc.) correlations are very low and mostly insignificant whereas within groups they tend to be much stronger. In addition, commodity futures are roughly uncorrelated with stocks and bonds. Still, correlations may vary somewhat over the different phases of the business cycle, suggesting that not all commodities make equally good diversifiers at all times. Copula-based tests do not indicate any deviant behaviour in the tails of the joint return distribution of commodity futures and stocks or bonds. Contrary to equities and bonds, we show that commodity futures returns are positively correlated with unexpected inflation (i.e. 25% on average with CPI inflation as opposed to 30% for equities and 50% for bonds). There are significant differences between the various commodities, however, with energy, metals, cattle, and sugar offering the best hedging potential. Altogether, assuming that the observed regularities will persist, our results confirm that a well-balanced commodity futures portfolio could offer a worthwhile diversification service to the typical traditional investment portfolio. Click here for full article
  Harry M. Kat, Cass Business School
  Roel Oomen, Warwick Business School
  
• Absolute Returns in Commodity (Natural Resources) Futures Investments.
  
  
  In this chapter, we introduce readers to commodity (natural resource) futures programs. We begin the chapter 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."
  The second section of the chapter discusses how (real) spot commodity prices have been in a long-term secular decline, which has meant that in the past, most arguments for investing in commodities have had to rely on one of the two following rationales. An investment in a commodity futures program has had to (1) capture cyclical opportunities, or (2) provide an inherent risk premium that has only been available in certain futures markets. This latter concept is admittedly esoteric and will be explained later in this chapter.
  In the chapter’s third section we will argue that current commodity investment programs, which are designed to either capture cyclical opportunities or monetize risk premia, are still valid in the current environment. But we will further note that one can also make a plausible case for investing in commodities based on increases in spot commodity prices. The 1990’s were marked by “a series of unusually favorable supply shocks,” which may not be the case going forward, as O’Neill of Goldman Sachs et al. (2004) have warned. In the concluding section of the article, we will outline the risk management requirements for a commodity investment program, given that absolute-return investors require that hedge funds control downside risk rather than just “capture the premium of the asset class,” as Ineichen of UBS (2003) has explained. Click here for full article
  Hilary Till, Premia Capital Management
  Jodie Gunzberg,Ibbotson Associates
  
• Does Optimizing Fund Growth Require Managerial Skill?
  
  
  Optimizing fund growth maximizes fund value. We argue that growth in fund size results from managerial skill. To test this argument, we estimate a model that links fund growth to performance characteristics. We use the model to isolate significant performance characteristics, and then confirm that the model has predictive power out-of-sample. This predictive ability suggests that a manger can employ strategies to optimize his fund’s size and hence maximize overall fund value, thus demonstrating skill.
  Click here for full article Paul Lajbcygier
  Clayton School of IT, Monash University, Australia
  
• Future Risk
  
  
  In November, we discussed risk modeling of credit spreads. We raised two broad questions. First, we asked which market should we look to for information. And when credit is traded in more than one market, should we choose the one with the greatest liquidity, or the one that most closely matches our position? Second, we asked what made a time series useful as a risk factor, and whether we could choose among a variety of definitions of spread to obtain the best properties for forecasting purposes. A third question we could have asked, but did not, was how we should model the volatility once we had obtained a useful time series. We picked up that question in our December note.
  In this note, we ask the first two questions again, but for futures contracts rather than credit spreads. As we will discuss, there are modeling choices we have applied for a long time which, while serving us well broadly, are in fact questionable in specific cases. Moreover, it is never a bad thing to return to models that have been around a while, and revisit the thinking that led us to those choices in the past.
  Click here for full article Christopher Finger and Luis O'Shea
  Riskmetrics
  
• Separating the Wheat from the Chaff: Backwardation as the Long-Term Driver of Commodity Futures Performance.
  
  
  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 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 historical examination of soybean production and trading suggests that the profitability of a passive long soybean position during the early part of our sample may have resulted from inadequate inventories and storage facilities at the time. These conditions created the conditions for demand-driven price spikes. Further, the thin margins of soybean processors likely increased hedging demand. The implications for commodity investing are considered. Click here for full article
  Barry Feldman, Russell Investment Group and Prism Analytics
  Hilary Till, Premia Capital
  
• What Every Investor Should Know About Commodities. Part I: Univariate Return Analysis.
  
  
  In this paper we study the univariate return properties of a large variety of commodity futures. Our analysis shows that the volatility of commodity futures is comparable to that of US large cap stocks. Yet, with the exception of energy, a consistently positive risk premium is lacking in commodity futures. We also find that for many commodities, futures returns and volatility can vary considerably over different phases of the business cycle, under different monetary conditions as well as with the shape of the futures curve. Skewness in commodity futures returns is largely insignificant, whereas kurtosis is significantly positive and comparable to that of US large cap stocks. In almost all commodities we find significant degrees of autocorrelation, which affects the properties of longer horizon returns. Click here for full article
  Harry M. Kat, Cass Business School
  Roel C.A. Oomen, Warwick Business School
  
• Superstars or Average Joes? A Replication-Based Performance Evaluation of 1917 Individual Hedge Funds
  
  
  In this paper we use the hedge fund return replication technique recently introduced by Kat and Palaro (2005) to evaluate the net-of-fee performance of 1917 individual hedge funds. Comparing fund returns with the returns on dynamic futures trading strategies with the same risk and dependence characteristics, we find that no more than 17.7% of the hedge funds in our sample beat the benchmark. In other words, the majority of hedge funds have not provided their investors with returns, which they could not have generated themselves by mechanically trading S&P 500, T-bond and Eurodollar futures. Over time, we observe a substantial deterioration in overall hedge fund performance. In addition, we find a tendency for the performance of successful funds to deteriorate over time. This supports the hypothesis that increased assets under management endanger future performance. Click here for full article
  Harry M. Kat and Helder P. Palaro
  Cass Business School
  
• Hedge Fund Transparency Increasing, 2005 Hedge Fund Database Study
  Strategic Financial Solutions
  
  
  January 5, 2006 – NEW YORK - Strategic Financial Solutions, LLC, (SFS) creator of the world’s leading asset allocation and investment analysis software, the PerTrac Desktop Analytical Platform, is pleased to present the aggregate results of the 2005 SFS Hedge Fund Database Study, an annual report that aims to shed additional light on the hedge fund industry. Click here for full article
• Does a Change in Risk Regime Spell Trouble for Hedge Funds?
  Conquest Capital Group LLC
  
  
  The risk-adjusted returns since inception of most hedge fund indices have been enhanced by a favorable environment and could be susceptible to a decrease in market risk appetite. However, this vulnerability is not uniform; managed futures strategies have proven more robust than other hedge fund strategies, yielding positive returns under both risk-seeking and risk-averse conditions.
  Risk-averse periods tend to cluster and therefore the current state of market risk appetite provides information about the future state of market risk appetite. These effects in combination mean that it is possible to enhance portfolio performance by combining a measure of risk aversion with allocations to the managed futures space. Click here for full article
• Volatility, Leverage and Returns
  
  
  In this paper, we attempt to fill this gap by developing a fundamental framework to project future market volatility. We then apply it to current conditions, expecting in 2006 a rebound in market volatility from depressed levels, but with high volatility delayed to 2007-08. We draw implication for asset returns, active returns, and for what policy markets should be looking out for. We come up with some expected results, but also with quite a few surprises (at least to us). Among these are that leverage by investors tends to lag, rather than lead market volatility; that corporate leverage and macroeconomic volatility are more causally related to market volatility; that hedge funds seem very reluctant to raise leverage, in contrast to banks; and that active investors tend to do poorly when volatility rises unexpectedly. Click here for full article
  Jan Loeys and Nikolaos Panigirtzoglou
  J.P. Morgan
  
• A Critique of the Sharpe Ratio
  
  
  The Sharpe ratio is a statistic which aims to sum up the desirability of a risky investment strategy or instrument by dividing the average period return in excess of the risk-free rate by the standard deviation of the return generating process. Devised in 1966 as a measure of performance for mutual funds, it undoubtedly has some value as a measure of strategy “quality”, but it also has several crucial limitations (see Sharpe 1994 for a recent restatement and review of its principles). Furthermore, its widespread and often indiscriminate adoption as a quality measure is leading to distortion of proper investment priorities, as investment firms manipulate strategies and data to maximise it. Click here for full article
  David Harding, Winton Capital Management
  
• 2005 Alternative Investor Survey
  
  
  Over 1,000 representatives from 650 firms completed the 2005 Deutsche Bank Alternative Investment Survey. These 650 investors represent $645 billion dollars in direct hedge fund assets, which we estimate is nearly two-thirds of all assets in the hedge fund industry. We asked each respondent to categorize themselves as a fund of funds, bank, corporation, consultant, insurance company, pension, endowment, foundation, family office or high net worth individual. We received responses from all these investor types, with a particularly strong showing from pensions, endowments and foundations, comprising 18% of respondents. Family offices and high net worth individuals are also well represented, at 15%. Funds of funds represent the largest group, with 43% of all responses. We polled investors from all over the world, with roughly half from the United States and more than a third from Europe. Click here for full article
  Deutsche Bank's Hedge Fund Capital Group
  
• The Right Place for Alternative Betas in Hedge Fund Performance: An Answer to the Capacity Effect Fantasy
  
  
  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, dynamic betas (i.e. factor timing), and pure alpha (i.e. security selection). Click here for full article
  Walter Gehin and Mathieu Vaissie
  Edhec Risk and Asset Management Research Centre
  
• Hedge Fund Returns: You Can Make Them Yourself!
  
  
  Over the last 10 years hedge funds have become very popular with high net worth investors and are currently well on their way to acquire a significant allocation from many institutional investors as well. The growing popularity of hedge funds and the availability of various hedge fund databases have spawned several hundreds of academic research papers on various aspects of the hedge fund industry and especially the risk-return performance of hedge funds and fund of funds. Many of these papers apply methods, like standard mean-variance and Sharpe ratio analysis for example, which are ill-suited for the analysis of hedge funds returns and have, as a result, produced incorrect conclusions. Fortunately, some studies have taken a more sophisticated approach and have made it clear that hedge fund returns are not really superior to the returns on traditional asset classes, but primarily just different. With hedge fund performance getting worse every year, the hedge fund industry has come to more or less the same conclusion. Unlike in the early days, hedge funds are no longer sold on the promise of superior performance, but more and more on the back of a diversification argument: due to their low correlation with stocks and bonds, hedge funds can significantly reduce the risk (as measured by the standard deviation) of a traditional investment portfolio without giving up expected return. Once we accept that hedge fund returns are not superior, but just different, the obvious next question is: is it possible to generate hedge fund-like returns ourselves by mechanically trading stocks and bonds (either in the cash or futures markets)? Although hedge fund managers typically put a lot of effort into generating their returns, maybe it is possible to generate very similar returns in a much more mechanical way and with a lot less effort. If it is, we may be able to do without expensive hedge fund managers and all the hassle, including the due diligence, the lack of liquidity, the lack of transparency, the lack of capacity, and the fear for style drift, which comes with investing in hedge funds. There might well be more than one road leading to Rome. Based on earlier work into hedge fund return replication by Amin and Kat (2003), we have done a lot of research in this area, which has lead to the development of a 3 general procedure that allows us to design simple trading strategies in stock index, bond, currency and interest rate futures that generate returns with statistical properties that are very similar to those of hedge funds, or any other type of managed fund for that matter. In what follows, we briefly describe this procedure as well as provide some examples of the procedure?s amazing results. Click here for full article
  Harry Kat, Helder P. Palaro
  
• Falling Knives Around the World
  
  
  U.S. stock market from 1986 through 2002. While the falling knives we identified did post a relatively high bankruptcy rate over the three-year period following their initial drop, they also outperformed the S&P 500 by wide margins. We followed up our study of U.S.-based falling knives by extending our falling knife analysis to markets outside the United States – and we concluded that non-U.S. knives also tended to outdistance their benchmarks. What’s new in this paper? First, we study both U.S. and non-U.S. falling knives over a synchronized time period: 1980 through the end of 2003. As a result, our analysis now includes many falling knives that were generated in 2000, when the generally high valuation levels of the late 1990s began to wind down amid the collapse of the technology stock bubble. We also take an in-depth look at falling knives over time, by sector, and – for non-U.S. knives – on a country-by-country basis. In addition, we test market capitalization and enterprise-value-to-sales ratios as possible predictors of falling knife performance. Click here for full article
  The Brandes University
  
• The Big One... The Asian Dollar
  
  
  Demographics, climate change, debt problems, deficit worries: the list of potential life changing events goes on. Yet there is one other decision that could overwhelm all these. If Asia – from Japan to China – formally begins to use the US dollar as their standard of value it will change the outlook for asset prices for decades to come. The idea is not fantasy. China’s latest infusion of cash into State banks suggests that floating the RMB may not be as high on the political agenda as some hope. Moreover, the long-term Yen outlook looks far from assured. A simple pan-Asian dollar fix would drive Asian asset prices sky-high. And it’s happened before: Japan fixed to the US dollar in 1949 at Y360 and Hong Kong fixed in 1983 at HK$7.80. Both markets subsequently enjoyed sharp increases in asset prices. Click here for full article
  CrossBorder Capital
  
• Is Indexing Suitable for Hedge Fund Investing?
  
  
  Hedge funds have become increasingly popular among institutional investors due to their potential for generating positive returns in any market environment. The recent growth in the number, style, and complexity of these investments has increased the importance of the fund-offunds service provider. More recently, investable hedge fund indices have emerged to represent a quasi-passive low-cost beta approach to hedge fund investing. On the other hand, fund-of-funds are being relied upon to provide manager selection, due diligence, asset allocation, and riskmonitoring advice to institutional investors who are resource-constrained; they are viewed as an active alpha-producing investment when compared with rules-based hedge fund indices. In this paper, we outline the theoretical and practical challenges of applying an investable index-based approach to an actively managed hedge fund industry, and seek to identify the potential value that fund-of-funds may provide. Click here for full article
  Jim Tomeo, Rob Covino, and Brian Chung
  SSaris Advisors, LLC
  
• The Continuing Case for Emerging Markets, Revisited
  
  
  In February 2004, Everest Capital authored a White Paper titled “The Continuing Case for Emerging Markets” highlighting our positive outlook for emerging markets equities. We revisit our thesis below, and reiterate our favorable view for the performance of the asset class. Click here for full article
  Everest Capital
  
• Hedge Funds Have Alpha is a Hypothesis Worth Testing
  
  
  In this article, we describe the reasons traditional performance evaluation approaches do not work—for traditional investments as well as hedge funds. However, unlike previous articles that have simply documented the problems, we offer a solution: Namely, performance evaluation in general, and hedge fund performance evaluation in particular, should be viewed as a hypothesis test where we assess the validity of the hypothesis “Performance is good.” To accept or reject this hypothesis, the textbooks say you should construct all of the possible outcomes and see where the actual performance result falls. If the observed performance is toward the top of all of the possibilities, the hypothesis is correct, and performance is good. Otherwise, it is not. In other words, the hypothesis test gives us a chance to determine if a manager truly has the skill to outperform a group of monkeys randomly playing the same game. Click here for full article
  Ron Surz, PPCA
  
• The Scrap Steel Standard
  
  
  The two most remarkable features in financial markets in recent years have been the plunge in stock market volatility and the bull market in credits. Together they have helped to sustain high valuation levels across world equity markets. Yet the two features are closely linked: their common factor being monetary policy, or more accurately monetary stability. In short, low currency market volatility has led to low stock market volatility, which, in turn, has fuelled the appetite for credit. We argue in this report that the world economy is operating two monetary standards. One looks rock steady; the other appears close to change. The bottom line is that financial markets may be nearer to the fault line than most investors believe. Volatility could jump and credits blow out. Click here for full article
  CrossBorder Capital
  
• On the Role of Hedge Funds in Institutional Portfolios
  
  
  Hedge funds do not easily fit into the current way institutions go about investing. Based on a survey of recent academic and practitioner research, this article reviews six competing frameworks for how to incorporate hedge funds in institutional portfolios. Each framework has very different implications for institutional asset allocation, manager selection, and benchmarking. Click here for full article
  Hilary Till, Premia Risk Consultancy, Inc.
  
• Investable Hedge Fund Indices
  
  
  Investable Hedge Fund Indices (IHFI’s) have grown in numbers since the first meaningful introduction of these during 2003. While making their presence wide spread through a number of main providers, investors have been left with the task of considering whether or not IHFI’s achieve in practice a better if not outright alternative to established Hedge Funds of Funds (HFOF’s ). What the assessments provided by this report show is that IHFI’s are not very different to HFOF’s and in many ways HFOF’s remain a more viable alternative. Large dispersions are shown to exist for the same types of Hedge Fund Strategies amongst the different IHFI providers. The subscription and redemption costs, notice periods and annual fees make the actual performance which investors can expect to realise from Buy and Hold investing, substantially less than that reported for the underlying indices on which the IHFI’s are based. In summary, many practical challenges remain open with investing in IHFI’s and will require considerable time and resources to shift the vote towards IHFI’s away from HFOF’s if at all. Click here for full article
  Jacobson Fund Managers Ltd
  
• The Role of Long/Short Equity Hedge Funds in Investment Portfolios
  
  
  Long/short equity hedge funds have historically outperformed traditional long equity exposure with lower risk. This is a result of a demonstrated capability by long/short managers to generate alpha via stock selection, rotation in and out of cash and timely shifts in market exposures (e.g. large vs. small capitalization, sector, geography, etc). As a consequence, long/short managers have tended to generate a highly favorable characteristic: a higher correlation to equity markets in rising markets and lower correlation in falling markets (sometimes referred to as an “asymmetrical” risk/return profile). Over the past decade, assets under management by long/short equity hedge funds have grown more than 20% annually. This expansion was the most rapid of any hedge fund strategy and long/short managers have displaced global macro funds to claim the largest share of industry assets. Although a portion of this growth in long/short assets was attributable to market appreciation, the demonstrated ability of the managers themselves was also a key factor stimulating inflows. In my view, the optimum portfolio allocation should include adequate doses of “unconstrained” long/short managers in lieu of passive or active long equity exposure. Indeed, if one relies solely on the historical performance record, long/short managers would entirely displace traditional long-only managers. This view holds up even when long/short manager returns are liberally adjusted downward to reflect possible survivor bias. And while there is no guarantee that long/short manager performance will hold up in the future, it would take a severe deterioration in manager capabilities to justify no allocation, in my opinion. There is no one preeminent asset allocation scheme for delineating the role of long/short hedge funds in portfolios—it depends on an investor’s current positions and portfolio management structure. Approaches include allocating to an aggregate long/short category and populating the space with generalist managers that invest broadly. Alternatively, one can distinguish between geographic markets (developed, emerging, etc) or invest in styles (value/growth) as part of the overall equity allocation. In this article, I make the case for incorporating the alpha-generating capabilities and the implicit beta exposure of long/short managers explicitly in the asset allocation process. The first section reviews the evolution of long/short hedge funds. The performance characteristics of the long/short managers are then reviewed in the second section. The third section describes the basic determinants of long/short manager returns. This is followed by an analysis of what allocations to long/short managers might make sense. The final section discusses the attributes of various long/short managers who specialize in sectors. The key conclusion is that long/short managers have a demonstrated ability to outperform on a risk-adjusted basis compared to most long-only vehicles. I believe substantial allocations to these managers are appropriate regardless of whether one views them as a substitute for active equity managers or as a stand-alone hedge fund strategy. Click here for full article
  R. McFall Lamm, Jr., DB Absolute Return Strategies
  
• The Capacity Implications of the Search for Alpha
  
  
  Anjilvel et al [2001] emphasize the “alpha advantage” of hedge fund managers. They write, “Our research has shown that a significant proportion of the total return to hedge funds in the past has been alpha, in contrast with a small negative total alpha for mutual funds …” They hypothesize, “One possible explanation for an ‘alpha advantage’ … is that … [the active managers] can forecast expected returns better than others. This means a significant ability to exploit market inefficiencies to outperform their benchmarks, presumably by virtue of skill, knowledge, and insight.” This view of hedge fund management has a direct impact on the potential capacity of the hedge fund industry. To figure out the capacity of the hedge fund industry, we start by quoting from Cochrane [1999]: “… the average investor must hold the market so portfolio decisions must be driven by differences between an investor and the average investor.” 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. Click here for full article
  Hilary Till, Premia Risk Consultancy, Inc.
  
• Facts and Fantasies About Commodity Futures
  
  
  We construct an equally-weighted index of commodity futures monthly returns over the period between July of 1959 and December of 2004 in order to study simple properties of commodity futures as an asset class. Fully-collateralized commodity futures have historically offered the same return and Sharpe ratio as equities. While the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with equity returns and bond returns. The negative correlation between commodity futures and the other asset classes is due, in significant part, to different behavior over the business cycle. In addition, commodity futures are positively correlated with inflation, unexpected inflation, and changes in expected inflation. Click here for full article
  K. Geert Rouwenhorst, Gary Gorton
  Yale School of Management, University of Pennsylvania
  
• Fund of Hedge Funds Portfolio Selection: A Multiple-Objective Approach
  
  
  This paper incorporates investor preferences for return distributions’ higher moments into a Polynomial Goal Programming (PGP) optimisation model. This allows us to solve for multiple competing hedge fund allocation objectives within a mean-variance-skewness-kurtosis framework. Our empirical analysis underlines the existence of significant differences in the return behaviour of different hedge fund strategies. Irrespective of investor preferences, the PGP optimal portfolios contain hardly any allocation to long/short equity, distressed securities, and emerging markets funds. Equity market neutral and global macro funds on the other hand tend to receive very high allocations, primarily due to their low co-variance, high co-skewness and low co-kurtosis properties. More specifically, equity market neutral funds act as volatility and kurtosis reducers, while global macro funds act as portfolio skewness enhancers. In PGP optimal portfolios of stocks, bonds, and hedge funds, where equity exposure tends to be traded off for hedge fund exposure, we observe a similar preference for equity market neutral and global macro funds. Click here for full article
  Ryan J. Davies, Harry M. Kat, and Sa Lu
  
• Weighing the Cost of Illiquidity
  
  
  Illiquidity is a common feature of alternative investments, but the diversity of hedge fund investments – including OTC derivatives – present special challenges. Hilary Till of Premia Capital Management reviews developments in quantitative techniques for evaluating the effect on performance. Click here for full article
  Hilary Till, Premia Capital Management
• Regulatory Analysis of Use of Security Futures Products by Investment Advisers, Investment Companies, Hedge Funds, Commodity Pools and Commodity Trading Advisors
  
  
  OneChicago, LLC has asked Gardner Carton & Douglas LLP to summarize the regulatory implications for funds and their advisors of investing or trading in security futures products (“SFPs”). SFPs are unique in that they are both securities and futures. Funds and investment managers must understand how the use of SFPs may affect their existing registrations and/or exemptions or trigger the need for new registrations or exemptions. To navigate the analysis, we have created separate links for each type of fund or advisor. To view a summary of the regulatory implications of using SFPs, click on to the link that corresponds to the situation that is relevant to you. Of course, if more than one situation is relevant to you, you should review each relevant link. The accompanying regulatory analysis is not intended to be exhaustive. It does not include an analysis of the implications of using SFPs under the Securities Act of 1933 or Securities Exchange Act of 1934. Further, this analysis is not legal advice, which may often turn on specific facts. Readers should seek specific legal advice from qualified counsel before acting with regard to the subjects mentioned here. Click here for full article
  David Matteson, Gardner Carton & Douglas
• Managed Futures Can Save Your Tail
  
  
  Some investors who are unfamiliar with managed futures are nervous about the volatility of the asset class. Unbeknownst to them, they may be missing an opportunity to reduce the overall risk of loss in their investment portfolios. Historically, diversified investment portfolios perform better and are less volatile when they include managed futures investments. Considering that returns from managed futures tend to be highly volatile, these assertions are counterintuitive. A clearer understanding of how this happens is obtained by studying the nature of managed futures’ returns and their correlation to stocks and bonds, especially during times of stress for financial markets. Click here for full article
  Steven Koomar, KV1 Asset Management LLC
• Hedge Fund Performance and Persistence in Bull and Bear Markets
  
  
  The paper tests the performance of 2894 hedge funds in a time period that encompasses unambiguously bullish and bearish trends whose pivot is commonly set at March 2000. Our database proves to be fairly trustable with respect to the most important biases in hedge fund studies, despite the high attrition rate of funds observed in the down market. We apply an original ten-factor composite performance model that achieves very significance levels. The analysis of performance indicates that most hedge funds significantly out-performed the market during the whole test period, mostly thanks to the bullish sub-period. In contrast, no significant under-performance of individual hedge fund strategies is observed when markets headed south. The analysis of persistence yields very similar results, with most of the predictability being found among middle performers during the bullish period. However, the Market Neutral strategy represents a remarkable exception, as abnormal performance is sustained throughtout and significant persistence can be found between the 20% and 69% best performers in this category, probably thanks to an extreme adaptability and a very active investment behavior. Click here for full article
  Daniel Capocci, Albert Corhay, and Georges Hubner
  University of Liege (Belgium)
• The Continuing Case for Emerging Markets
  
  
  Emerging markets have not yet fully made their way back onto investors’ radar screens. Those who have not looked at the asset class since the turmoil of the late 1990s may be surprised by what they find a mere five years later. Largely unnoticed, emerging markets have outperformed developed markets over the past one-, three- and five-year periods. Investment inflows into the asset class finally showed renewed signs of life in late 2003, following net outflows over the previous five years. This lack of investor interest was in stark contrast to the acceleration of foreign direct investment (FDI) during the same period. Click here for full article
  Everest Capital
• Alternative RAPMs for Alternative Investments
  
  
  The paper highlights the inadequacies of the traditional RAPMs (Risk-Adjusted Performance Measures) and proposes AIRAP (Alternative Investments Risk Adjusted Performance), based on Expected Utility theory, as a RAPM better suited to Alternative Investments. AIRAP is the implied certain return that a risk-averse investor would trade off for holding risky assets. AIRAP captures the full distribution, penalizes for volatility and leverage, is customizable by risk aversion, works with negative mean returns, eschews moment estimation or convergence requirements and can dovetail with stressed scenarios or regime-switching models. A modified Sharpe Ratio is proposed. The results are contrasted with Sharpe, Treynor and Jensen rankings to show significant divergence. Evidence of non-normality and the tradeoff between mean-variance merits vis-à-vis high moment risks is noted. The dependence of optimal leverage on risk aversion and track record is noted. The results have implications for manager selection and fund of hedge funds portfolio construction. Click here for full article
  Milind Sharma, Merrill Lynch
• A Detailed Analysis of the Construction Methods and Management
  Principles of Hedge Fund Indices - Are All Hedge Fund Indices
  Created Equal?
  
  
  His analysis highlights the strengths and weaknesses of the various hedge fund indices available in the market. Click here for full article
  Mathieu Vaissii, EDHEC
• Beware of Systematic Style Biases
  
  
  Marc Goodman, Kenneth Shewer and Richard Horwitz make the case that the style-based tailwinds that equity hedge funds have enjoyed over the past few years will shift, and could become dangerous headwinds for the unaware investor. Click here for full article
  Marc Goodman, Kenneth Shewer and Richard Horvitz
  Kenmar Global Investment
• Squeezing the Best from Hedge Fund Diversification
  
  
  Marc Goodman, Kenneth Shewer and Richard Horwitz explore whether hedge funds and fund of funds provide risk-efficient diversification, and how institutional investors can best allocate assets to achieve a superior risk/return relationship. Click here for full article
  Marc Goodman, Kenneth Shewer and Richard Horvitz
  Kenmar Global Investment
• What Drives Hedge Fund Returns?
  
  
  Hedge Funds are seen as an alternative asset class, but what does this really mean? We argue in this report that the long-run returns from hedge funds should differ little from other financial assets. However, their risk characteristics are significantly different, particularly when differentiated by their investment style. It is this characteristic that distinguishes them from conventional assets. Hedge funds are not higher risk and they are not necessarily lower risk: they simply have a different risk profile. As such they should be part of every asset allocation. Click here for full article
  Michael Howell, CrossBorder Capital Limited
• Hedge Funds Selling Beta as Alpha
  
  
  There are two ways to make money in financial markets. Beta - One way to make money in financial markets is to take on a systematic risk for which the market compensates you. This type of risk is known as beta. For instance, equities have a higher expected return than cash over time for the simple reason that they are a more risky investment than cash. The same is true of long duration bonds versus cash, corporate bonds versus treasuries, mortgages versus treasuries, emerging market debt versus developed market debt, etc. At any given point in time, risky financial assets may be expensive or cheap, but over time, they should return more than less risky assets. Betas are easy to capture (i.e. naïve investment strategies can capture betas). Over significant periods of time, betas have positive returns. However, they have low return to risk ratios (we estimate that, over long time-frames, betas have annual Sharpe ratios ranging from 0.2 to 0.3), and for the most part, they are correlated to one another (in part because risk itself is inherent in each of them). Alpha - The other way to make money in financial markets is by taking it away from other market participants. This is known as alpha. Alpha is zero-sum. For every buyer, there is a seller, and so for every alpha trade, there is both a winner and a loser. Examples of alpha strategies include market-timing and active security selection. Only investors who are smarter than the market will be able to reliably provide alpha. Click here for full article
  Greg Jansen, Bridgewater Associates
• Commentary on the Japanese Market
  
  
  The recovery seen in the Japanese market over the last couple of months begs the question, “is this the start of a new secular bull market or a cyclical uplift in the extraordinary oversold position we saw at the end of the fiscal year?” We do not have the definitive answer. Fortunately as a hedge fund of funds, we do not need to time our entry into the market but to be positioned to protect funds regardless of market direction and to make money where we can. We are, however, in a position to reflect on some of the prevalent views amongst our own managers and make some observations of our own. Click here for full article
  Nick Bullman, Chairman of Investor Select Advisors
• Is Asset Allocation Still Working?
  
  
  As the speculative bubble of '98-'99 gave way to the bear market of '00-'01, pension sponsors found that traditional diversification methods have not hedged as much of the market decline as hoped - providing little absolute return protection. In particular, pension surpluses have been shrinking to the point where many organizations will be faced with a need to contribute additional funds to their pension plans just as their earnings are falling due to the economic slow-down. Therefore, it's not surprising that investors are increasingly drawn to a new strategy that's relatively unaffected by the markets and the economic environment: market neutral investing. With strong positive returns and low levels of volatility, market neutral strategies are making their way into the asset allocation plans of a growing number of institutional and other qualified investors. Incorporating investment techniques that, in isolation, have historically been considered "risky", investors are discovering that certain market neutral strategies are, in fact, less risky than traditional equity investments. Click here for full article
  Edgar E. Peters, Panagora Asset Management
• Timing Multiple Markets: Theory and Evidence
  
  
  I extend the classical market timing model of Merton (1981) to the case of multiple risk factors and show that the equilibrium value of a market timer’s forecasting ability can be written more generally as a weighted-sum of Arrow-Debreu-type contingent claim prices. Following these results I develop a class of return-based parametric tests to evaluate the ability of a portfolio manager to ‘time multiple markets’. I apply these tests to evaluate the performance of ‘fund of funds’ hedge fund managers. I show that, both individually and on aggregate, fund of funds managers do not exhibit timing ability with respect to a variety of hedge fund styles. However, I argue that this result is due to frictions created by the hedge funds into which these vehicles invest. Click here for full article
  George O. Aragon
  The Wallace E. Carroll School of Management - Boston College
• Portfolio Optimization and Hedge Fund Style Allocation Decisions
  
  
  This paper attempts to evaluate the out-of-sample performance of an improved estimator of the covariance structure of hedge fund index returns, focusing on its use for optimal portfolio selection. Using data from CSFB-Tremont hedge fund indices, we find that ex-post volatility of minimum variance portfolios generated using implicit factor based estimation techniques is between 1.5 and 6 times lower than that of a value-weighted benchmark, such differences being both economically and statistically significant. This strongly indicates that optimal inclusion of hedge funds in an investor portfolio can potentially generate a dramatic decrease in the portfolio volatility on an out-of-sample basis. Differences in mean returns, on the other hand, are not statistically significant, suggesting that the improvement in terms of risk control does not necessarily come at the cost of lower expected returns. Click here for full article
  Noël Amenc and Lionel Martellin
  EDHEC Risk and Asset Management Research Centre
• The Brave New World of Hedge Fund Indices
  
  
  That hedge funds have started to gain widespread acceptance while remaining a somewhat mysterious asset class enhances the need for better measurement and benchmarking of their performance. One serious problem is that existing hedge fund indices provide a somewhat confusing picture of the investment universe. In this paper, we present detailed evidence of strong heterogeneity in the information conveyed by competing indices. We also attempt to provide remedies to the problem and suggest various methodologies designed to help build a “pure style index”, or “index of the indices”, for a given style. Finally, we present evidence of the ability of pure style indices to improve benchmarking of hedge fund returns. Our results can be extended to traditional investment styles such as growth/value, small cap/large cap. Click here for full article
  Noël Amenc and Lionel Martellin
  EDHEC Risk and Asset Management Research Centre
• The Pros and Cons of 'Drawdown' as a Measure of Risk for Investments
  
  
  A key measure of track record quality and strategy “riskiness” in the managed futures industry is drawdown, which measures the decline in net asset value from the historic high point. In this discussion we want to look at its strengths and weaknesses as a summary statistic, and examine some of its frequently overlooked features. Click here for full article
  David Harding, Georgia Nakou and Ali Nejjar
  Winton Capital Management
• Trend Following: Performance, Risk, and Correlation Characteristics
  
  
  The growth in demand for hedge funds since 1995 has been significant. During this period, the assets invested in hedge funds grew from an estimated $100 billion to over $500 billion. Ultimately, the sustainability of this growth depends upon the relative and absolute investment performance ofthe hedge fund industry. Hedge funds provide sophisticated investors with access to virtually every investable asset class combined with the expertise needed to manage these complex investments. These investors receive positive returns, enhanced diversification when combined with stocks and bonds, low volatility, and protection against significant drawdowns..This paper discusses systematic trend following, a hedge fund style that has a 20 year track record of producing positive annual returns with low to negative correlation to most other asset classes and hedge fund strategies. Exhibit I compares the ZCM/MAR Trend Following Index versus the S&P 500 and the Lehman Treasury Bond Index since 1983. Click here for full article
  Michael S. Rulle, Presiden, Graham Capital Management
• Risk Considerations Unique to Hedge Funds
  
  
  Hilary Till continues in the spirit of her August 2002 Quantitative Finance feature on measuring risk-adjusted returns in alternative investments. Click here for full article
  Hilary Till, Premia Capital Management
• Managed Futures and Hedge Funds: A Match Made in Heaven
  
  
  In this paper we study the possible role of managed futures in portfolios of stocks, bonds and hedge funds. We find that allocating to managed futures allow investors to achieve a very substantial degree of overall risk reduction at limited costs. Apart from their lower expected return, managed futures appear to be more effective diversifiers than hedge funds. Adding managed futures to a portfolio of stocks and bonds will reduce that portfolio?s standard deviation more and quicker than hedge funds will, and without the undesirable side-effects on skewness and kurtosis. Overall portfolio standard deviation can be reduced further by combining both hedge funds and managed futures with stocks and bonds. As long as at least 45-50% of the alternatives allocation is allocated to managed futures, this again will not have any negative sideeffects on skewness and kurtosis. Click here for full article
  Harry M. Kat, The University of Reading (UK)
• Hedge Fund Diversification: How Much Is Enough?
  
  
  There are many benefits to investing in hedge funds, particularly when using a diversified multi-strategy approach. Over the recent years, multi-strategy funds of hedge funds have flourished and are now the favorite investment vehicles of institutional investors to discover the world of alternative investments. More recently, funds of hedge funds that specialize within an investment style have also emerged. Both types of funds put forward their ability to diversify risks by spreading them over several managers. However, diversifying a hedge fund portfolio also raises a number of issues, such as the optimal number of hedge funds to really benefit from diversification, and the influence of diversification on the various statistics of the return distribution (e.g. expected return, skewness, kurtosis, correlation with traditional asset classes, value at risk and other tail statistics). In this paper, using a large database of hedge funds over the 1990-2001 period, we study the impact of diversification on naively constructed (randomly chosen and equally weighted) hedge fund portfolios. We also provide some insight into style diversification benefits, as well as the inter-temporal evolution of diversification effects on hedge funds. Click here for full article
  François-Serge Lhabitant and Michelle Learned
  Thunderbird, the American Graduate School of International Management
• Managed Futures: A Real Alternative
  
  
  Managed Futures investments performed well during the global liquidity crisis of August 1998. In contrast to other alternative investment strategies, the performance of Managed Futures was good in that year and had once more demonstrated their diversification potential. More assets did subsequently flow into Managed Futures, but 1999 did turn out to be one of the worst performing years for the industry. Since then, the performance as well as the acceptance of Managed Futures has improved. As the global stock markets are declining, an increasing number of investors is getting attracted to the strategy. The following article will take a closer look at this asset class. Click here for full article
  Gildo Lungarella, Harcourt AG
• Hedge Funds with Style
  
  
  The popular perception is that hedge funds follow a reasonably well defined market-neutral investment style. While this long- short investment strategy may have characterized the first hedge funds, today hedge funds are a reasonably heterogeneous group. They are better defined in terms of their freedom from the constraints imposed by the Investment Company Act of 1940, than they are by the particular style of investment. We study the monthly return history of hedge funds over the period 1989 through to January 2000 and find that there are in fact a number of distinct styles of management. We find that differences in investment style contribute about 20 percent of the cross sectional variability in hedge fund performance. This result is consistent across the years of our sample and is robust to the way in which we determine investment style. We conclude that appropriate style analysis and style management are crucial to success for investors looking to invest in this market. Click here for full article
  Stephen J. Brown, NYU Stern School of Business
  William N. Goetzmann, Yale School of Management
• Stocks, Bonds and Hedge Funds: Not a Free Lunch!
  
  
  We study the diversification effects from introducing hedge funds into a traditional portfolio of stocks and bonds. Our results make it clear that in terms of skewness and kurtosis equity and hedge funds do not combine very well. Although the inclusion of hedge funds may significantly improve a portfolio’s mean-variance characteristics, it can also be expected to lead to significantly lower skewness as well as higher kurtosis. This means that the case for hedge funds includes a definite trade-off between profit and loss potential. Our results also emphasize that to have at least some impact on the overall portfolio, investors will have to make an allocation to hedge funds which by far exceeds the typical 1-5% that many institutions are currently considering. Click here for full article
  Guarav S. Amin and Harry M. Kat
  The University of Reading (UK)
• Returns-Based Analyses of Hedge Funds
  
  
  This column will discuss the state of the art in applying returns-based analyses to hedge funds. It will pay particular attention to those hedge fund strategies where the use of derivatives and dynamic trading strategies can lead to highly assymetric outcomes. Click here for full article
  Hillary Till, Premia Capital Management
• How to Incorporate Hedge Funds and Active Portfolio Management into an Asset Allocation Framework
  
  
  Hedge funds and other actively managed strategies contain two fundamental sources of risk: 1) Systematic risk - the risk associated with exposure to market-wide influences such as the broad equity or fixed-income market, and 2) Active risk - the risk associated with the performance of active managers relative to their market benchmarks. The conventional asset allocation approach employed by most plan sponsors and consultants fails to integrate these two sources of risk. This can lead to the formation of inefficient portfolios. In this article we propose a risk allocation framework that focuses on risk exposures instead of asset class exposures. Click here for full article
  Brett H. Wander and Dennis M. Bein
  Analytic Investors
• Private Placement Life Insurance
  The New Alternative in Insurance
  
  
  Within this report, we attempt to illustrate a simple bridge between hedge fund and insurance language and products, attempting to uncover the edge that exists in combining these fundamental vehicles of traditional and alternative investment worlds. Click here for full article
  Brad Cole and Christine Kailus
  Cole Partners
• Alternative Asset Strategies:
  Early Performance in Hedge Fund Managers
  
  
  This paper investigates the effects of age on hedge fund performance. In particular, we seek to ascertain whether hedge funds perform better during the early stages of their development. Existing studies seem to lack practicality and conclusiveness, with some studies failing to address adequately the issues of survivor and market biases. Survivor bias results from the tendency of hedge funds with poor performance to drop from available databases, causing industry performance returns to appear better than they are in reality. Market bias suggests that the recent success of many hedge funds results from strong general market performance and not necessarily from hedge fund managers’ skills. Unfortunately, the lack of complete and consistent data makes addressing these biases difficult. As hedge funds disappear from databases, survivor bias becomes embedded in available data. In addition, since most hedge fund databases only have significant information for the past five to ten years (coincident with one of the strongest U.S. equity market periods) market bias would also seem to be inherent in the data. In order to attempt to address these issues, this study has compiled information from various sources, including “deceased” funds, to create a more comprehensive database of available hedge fund information. Additionally, hedge fund returns were calculated according to age rather than vintage so that not all “early” returns come from the same market period. Where appropriate, subsets of this database were used. In all cases, individual hedge fund return data and not hedge fund style or hedge fund index data was used.1 Based upon this data, our conclusion is that despite the biases found in the data, investors may gain enhanced returns by investing in young hedge funds if proper due diligence is completed. Hedge funds under three years of age tend to perform better than do older hedge funds without necessarily adding to the volatility of returns. Click here for full article
  Patricia Jen, Chris Heasman, and Kit Boyatt
  Lazard
• Tail or Dog - The Pond's Getting Crowded
  
  
  Given the tremendous rise in hedge fund assets, one of the most common queries we receive from clients today is: Have hedge funds grown to the point where they are no longer the market tail but the entire dog? And if hedge funds have become the market dog, does the dog now have fleas? That is has the proliferation of hedge funds created yet one more bubble that needs to be popped before the market can resume even a vague semblance of normal behavior? Click here for full article
  Steve Galbraith and Mary Viviano
  Morgan Stanley
• A Risk Too Big to Comprehend
  
  
  Innovative financial engineers in alternative investments are knitting a web of complex interdependencies, yet no one has a masterplan. Click here for full article
  Jonathan Spring, President, Spring Investor Services
• Measure for Measure
  
  
  In a previous article Hillary Till touched upon the difficulty of using standard measures to evaluate certain hedge fund strategies. Here, after reviewing these difficulties, she discusses state-of-the-art solutions. Click here for full article
  Hillary Till, Principal, Premia Capital Management, LLC
• A Mutually Rewarding Enterprise?
  
  
  Randy Warsager examines the treasures and the pitfalls awaiting those who make the transition from traditional to hedge fund manager. Click here for full article
  Randy Warsager
• Are Investors Over-Invested In Equities?
  Professor Fernando Diz, Syracuse University
• Managed Futures: Out of Favor, or Outta Here?
  
  
  Selling managed futures to institutional investors is like trying to get the National Bowling Championships on primetime network TV. While the networks are making unprecedented allocations of primetime to sports coverage, bowling gets a continually smaller slice. In fact, I’ve heard of one venture capitalist who is buying up all the bowling alleys in the country in order to launch a new craze, Ballroom Hurdle Dancing. Really, it is easy to pick on managed futures. In fact, the only reasons more people are not kicking managed futures is because they are too busy gagging on their distressed debt, high tech and value equity investments. The Barclay Systematic Traders index which some consider to be the core CTA index was –3.63% for 1999 and is –1.70% through September 2000. But is managed futures a strategy that is just out of favor or are the wheels falling off the cart? Through a series of interviews with database providers, investors, distributors and managers, we estimate a net outflow of assets due to poor performance and redemptions somewhere between of between 35% to 50% over the last eighteen months. We also feel the number of players has been trimmed by about 30%. Our source for these numbers was not purely scientific, but as a 20-year participant in the futures industry, we have had to do some digging – enough to make us believe that this group is truly at a crossroads. Herein, we cut through the carnival of marketing jargon to find the real drivers running CTA-land. Click here for full article
  Brad Cole, President, Cole Partners
• Managing Investor Drawdowns Through a Risk Control Plan:
  A New Model for Evaluating Manager Performance
  Tushar Chande, President
  LongView Capital Management, L.L.C.
• The Benefits of a Long Volatility Investment Approach in a Multi-Fund Portfolio
  Alan R. Kaufman
  Chief Investment Officer, Trilogy Capital Management Group, L.L.C.
• Risk Management: A Practical Approach to Managing a Portfolio of
  Hedge Funds for a Large Insurance Company
  Norman Chait, CFA, AIG Global Investment Corporation