The year has been exceptionally volatile not only for equities but also for the VIX itself fluctuating between 13% and 24% since the start of 2016. MMA Pan Asia Fund I Management believes the volatility is a result of bond investors driven to chase risk and yield in equities, and shares with us their market commentary for June 2016.
"Volatility strategies are distinct and non-homogeneous, making it critical to segregate into separate categories to effectively analyze and properly benchmark performance. The CBOE Eurekahedge Volatility Indexes were specifically created to address this challenge and, based on our analysis, we strongly believe they provide a robust and innovative solution to volatility-based strategy benchmarking and due diligence."
The Eurekahedge 50 (EH50) index was designed to represent the exposures and experience of institutional hedge fund investors. Seeking to create a more selective benchmark reflective of diversified, institutional-quality multi-manager portfolios, Markov Processes International (MPI), in partnership with Eurekahedge, launched this unique Index in December 2014. After its first full year, the industry’s first measure of the collective performance of top hedge funds delivered better risk-adjusted returns with fewer turnovers than all-inclusive hedge fund indices.
Commodities as an asset have the highest volatility, the largest left tail risk, inherent leverage and the highest time varying correlation risk, making them the Black Sheep of the Black Swan family. We examine these four topics in some depth. Everyone is now invested in commodities of some type, mostly gold, making this a current concern.
The 2008 crisis was substantially defined by investors rushing out of risk-based assets and into the safety of government securities and cash as the classic flight-to-safety. This shift out of risk assets put tremendous pressure on prices: sharp declines in equities, corporate bonds, commodities and all sorts of derivatives; volatility spikes to record highs; bid-offer spreads at unheard of levels and so on. By the end of 2008, it seemed as if the world would come to a screeching halt.
We often hear that investors need to have diversified portfolios to protect against market volatility. However, as many investors found out during the bear markets of 2000-2002 and 2007-2008, a traditionally-diversified portfolio does not provide much downside protection when the market crashes and takes everything down with it.
The past year has been a difficult one for hedge funds. Market conditions, regulatory emergency orders and volatility all affected the ability of funds to develop and maintain strategies that made for consistent performance. Even in that context, funds tended to perform “better” (meaning performing less worse) than traditional asset managers.
2008 will be long remembered as the year of the liquidity crisis. Within a few months, the competitive landscape of global financial intermediaries was reshuffled. With credit markets frozen, the main equity markets suffered decline of 40% or more and continue to display staggering volatility not seen in generations. The most visible early casualties of the crisis were the large independent investment banks. With governments in Europe and the US now being shareholders in a wide array of financial institutions, the financial world has changed for good. And it is reasonable to expect that more changes are on the way. These tumultuous times have a profound and lasting impact on the hedge fund industry.
The financial crisis that began more than a year ago now, after the sudden fall in the prices of investments backed by subprime loans, sent shockwaves through the markets, with unprecedented write-downs of asset values continuing to undermine the foundations of the banking system and leading to a pronounced economic slowdown. The great increase in risk aversion ultimately led to great adjustments in the stock markets. Since the initial falls of June 2007, the major stock market indices have posted losses in the double digits. Volatility has increased abruptly; in the first quarter of 2008 it was twice its second quarter 2007 low.
Market volatility has increased tremendously and traders love it. Volatility has exceeded recent highs, and in certain instruments such as Hang Seng futures and options, has reached all-time highs. Indices have been going up and down in large amounts, not just for limited bursts but continuously.
In today’s global marketplace, real estate is coming of age as an asset class, alongside stocks and bonds. It also corresponds to a period in which real estate returns generally exceeded those of stocks and bonds, with real estate offering stable returns in a period of stock market weakness and volatility. Investors have been asking themselves, “Why International?”. They normally look at various factors and have allocated their investment funds based on returns or diversification of their portfolios. Investors (from both the United States and Asia Pacific) have a wealth of opportunities available in their domestic markets and thus investing in foreign assets has been largely discretionary.
As part of alternative investment ideas, volatility trading strategies could be filed under the existing category of “volatility arbitrage” and “relative value arbitrage”.
Options are often viewed as complex financial instruments on the capital markets, so the opportunities of volatility as a source of investment returns are often overlooked. Implemented by an experienced derivatives trader, volatility-orientated trading strategies often have a stabilising effect on an investor’s portfolio because of their correlation to classic long-only bond investments, for example, bonds, shares and property. They reduce the risk and often act as an insurance against external shocks.
The potential benefits of funds of funds are lively debated in the private equity industry. How can a fund of funds manager justify the additional fee layer? Do funds of funds deliver excess returns? We argue that fund of funds investors may indeed benefit from attractive risk-adjusted returns: firstly, because diversification does reduce volatility; and secondly, because diversification may even increase returns. Nevertheless, funds of funds managers that want to justify their services going forward will have to add value beyond the common claim for premier fund selection and diversification.
The CET Capital investment strategies aim to exploit persistent price behaviour of the small-cap stock indices and mutual funds. While some of CET Capitals' methodologies are proprietary, exploiting persistent price behaviour which is the foundation of what we do is not. Persistency, as defined by Gil Blake, is a combination of volatility and historical reliability. Below I will summarise an interview in Jack Schwagers' book, The New Market Wizards, which eloquently describes how a successful money manager named Gil Blake capitalised on persistency in the 1980s.
A recent EDHEC study on the use of hedge funds in asset-liability management has concluded that "allocating 20% to hedge funds can reduce a fund's probability of extreme loss by 50%". This conclusion has received quite some attention in the media (see the above quotes for example) and any hedge fund marketers have already eagerly incorporated it in their sales pitch. The question, however, is whether it is indeed such a remarkable finding as many people seem to believe. After all, diversification reduces volatility and lower volatility means less extreme risk. What therefore needs to be shown is that the obtained reduction in extreme risk exceeds what one would normally expect from allocating 20% to a new diversifier.
A slew of studies have concluded that newer hedge funds have outperformed their more seasoned peers. Table 1 summarises three of these studies (Jen, Heasman & Boyatt, 2001; Tremont/Tass, 2000; HFR, 2000) with adjustments for survivor bias ranging from 2.9% in year one to 0.9% in year six of existence. The left side of Table 1 shows a 700-basis point advantage between funds in their first year versus year seven. Note that volatility as measured by annualised standard deviation is relatively unchanged regardless of the fund's year in business.
To construct an optimal fund of funds, the risk and return of each hedge fund included need to be identified. In this article, we will focus on defining the kinds of risk and return required.
First, we have to define what the risk is for a hedge fund investor or a fund of funds investor. Risk is the possibility that, in the future, the investment's value will be lower than today's value or lower than a certain threshold. This threshold might, for example, be the 5% annualised return for a Swiss pension fund. Does volatility measure that? The answer is no. This is why a better measure of risk is downside risk. Downside risk can be the Omega measure, the Modified Value-at-Risk, the Conditional Value-at-Risk or the downside volatility.
The Conquest Managed Futures Select (MFS), along with other domestic and offshore funds, is managed by Conquest Capital LLC, a Commodity Trading Advisor (CTA) specialising in the trading of futures and FX markets globally. Conquest Capital LLC is a wholly owned subsidiary of the Conquest Capital Group, which also manages a multi-manager portfolio through another subsidiary – Condor Capital LLC. The management firm handles an asset base of about US$382 million, and has ten employees including five investment professionals.