Alternative Investment Strategies Research Articles

Welfare analysis of conditional indexation schemes from a two-reference-point perspective

AbstractConditional indexation has recently attracted interest with pension funds that are looking for a middle way between defined benefit and defined contribution. In this paper, we analyze conditional indexation schemes from a life-cycle investment perspective. Welfare analysis is applied to investigate the performance of such schemes relative to alternative investment strategies such as fixed-mix policies. We carry out this analysis in the context of a broad family of utility functions, which takes into account the possible presence of two benchmark levels corresponding to a minimum guaranty and to full indexation, respectively. For the purpose of comparability, we construct a self-financing continuous-time implementation of the conditional indexation scheme. The implementation involves continual adjustment of the parameters of the contingent claim representing final payoff. Our findings indicate that, in situations where large weight is placed on the benchmark levels, conditional indexation is fairly close to being optimal.

What if…? Utility vision 2020

Future climate frameworks, the localization of energy policy, energy–water linkages, consumer-driven innovation, are among the key words that keep utility strategists awake. This essay is an attempt to put these questions into context and derive a possible alternative investment strategy.

How Many Alternative Eggs Should You Put in Your Investment Basket?

There is some debate about how many stocks can effectively eliminate most of the unsystematic risk in an equity portfolio. Estimates range from ten to 40. Given the growing proliferation of pooled investment vehicles aimed at the UK's pension fund industry, where these pools consist of various combinations of alternative asset classes and alternative investment strategies, in this paper we investigate the limits of diversification amongst these less conventional investments. Our results indicate that 40per cent of the time series risk can be eliminated by combining eight strategies, but only a further four per cent from combining 12. We also find that an investor could reduce 60per cent of the dispersion in terminal wealth of an alternative investment basket - which is arguably what investors should really be concerned with - by combining six of these less conventional asset approaches to investment, but only a further 20 per cent by combining 15.

On Improving the Reliability of Distribution Networks Based on Investment Scenarios Using Reference Networks

Distribution systems are inherent monopolies and therefore these have generally been regulated in order to protect customers and to ensure cost-effective operation. In the UK this is one of the functions of OFGEM (Office of Gas and Electricity Markets). Initially the regulation was based on the value of assets but there is a trend nowadays towards performance-based regulation. In order to achieve this, a methodology is needed that enables the reliability performance associated with alternative investment strategies to be compared with the investment cost of these strategies. At present there is no accepted approach for such assessments. Building on the concept of reference networks proposed in Refs. (1), (2), this paper describes how these networks can be used to assess the impact that performance driven investment strategies will have on the improvement in reliability indices. The method has been tested using the underground and overhead part of a real system.

Variable Annuities and the New Retirement Realities

People today face the prospect of a retirement that may likely last 25 years or even longer. Concerns about the stock markets' volatility and the potential impact on their portfolios has caused many individuals approaching retirement to retreat from investments in equities and shift into fixed-income assets, despite historical evidence that investment in equities provide long-term returns superior to fixed-income returns. This conservative approach, embodied in such tools as Target Date Funds, for some investors could hamper asset accumulation and may make it less likely that assets will remain adequate to provide sustained sources of income during a lengthy retirement period. The insurance industry is uniquely positioned to offer those nearing retirement an alternative investment and risk management strategy through variable annuities. Features in the newer variable annuity product designs encourage individuals to remain invested in equities at older ages by cushioning them from some of the consequences of market volatility. As a result, investors are more apt to maintain a more equity-weighted investment portfolio and thereby have an opportunity to realize a greater portion of the superior growth potential that equities have historically provided over the long term.

The effects of mean reversion on alternative investment strategies

PurposeThe purpose of this study is to investigate the relationship between predictability in return and investment strategy performance. Two measures that characterize investment strategies within a mean‐variance framework, an activity measure and a style measure, are developed and the performance of alternative strategies (e.g. contrarian, momentum, etc.) is examined when risky asset returns are mean reverting.Design/methodology/approachReturns are assumed to follow a multivariate Ornstein‐Uhlenbeck process, where reversion to a time‐varying mean is governed by an additional variable set, similar to that proposed by Lo and Wang (1995). Depending on its parameterization, this process is capable of producing an autocorrelation pattern consistent with empirical evidence, that is, positive autocorrelation in short‐horizon returns and negative autocorrelation in long‐horizon returns.FindingsThe results, for four uninformed investment strategies and assuming that returns are generated by a simple univariate Ornstein‐Uhlenbeck process, show that the unadjusted returns from the contrarian (momentum) strategy are greater than those from the other strategies when the mean reversion parameter, α, is greater than (less than) one. The results are expected, given the relationship between α and the first‐order autocorrelation in returns. The risk level (measured by either the standard deviation of returns or beta) of the contrarian strategy is the lowest at essentially all levels of mean reversion and the risk‐adjusted returns from the contrarian strategy, measured by the both the Sharpe and Treynor ratios, dominate those from the other strategies.Research limitations/implicationsIn future research, a number of issues not considered in this study may be investigated. The style measure developed here can be used to determine whether the results obtained hold when an informed, mean‐variance efficient active strategy is employed. In addition, the performance of both the informed and uninformed strategies may be examined under the assumption that the risky return process follows a multivariate Ornstein‐Uhlenbeck process. This work should provide findings that facilitate the separation of fund risk due to dynamic strategies from that due to time‐varying expected returns.Practical implicationsThe methodology used here may be easily extended to consider a number of important issues, such as the frequency of portfolio rebalancing, transactions costs, and multiple asset portfolios, that are encountered in practice.Originality/valueThe approach used here provides insight into how predictability affects the relative performance of tactical investment strategies and, thus, may serve as a basis for determining the magnitude and persistence in autocorrelation required for active investment strategies to yield profits significantly different from those of passive strategies. In this sense, this study may have appeal for both academics and investment professionals.

Determining Return on Long-Life Pavement Investments

It is becoming increasingly necessary in life-cycle analysis (LCA) of infrastructure assets, including pavements, to take a longer-term approach than has been used, mainly to ensure sustainability and assess the impacts of today's decisions accurately. LCA can include primarily life-cycle cost analysis (LCCA), but it also can include considerations of resource conservation, environmental impacts, energy balance, and so forth, and it can involve short-, medium-, and long-term periods. It is thus possible to develop a context for LCA of likely and uncertain societal activities, including transportation, over these periods. Conventional LCCA is directed toward comparing competing alternative investment strategies and can involve a range of stakeholders. Of the methods available, present worth of costs is almost exclusively used in the pavement field. However, when medium- to longer-term life-cycle periods are involved, rate-of-return and cost-effectiveness formulations can be applicable. A numerical example ...

Determining Return on Long-Life Pavement Investments

It is becoming increasingly necessary in life-cycle analysis (LCA) of infrastructure assets, including pavements, to take a longer-term approach than has been used, mainly to ensure sustainability and assess the impacts of today's decisions accurately. LCA can include primarily life-cycle cost analysis (LCCA), but it also can include considerations of resource conservation, environmental impacts, energy balance, and so forth, and it can involve short-, medium-, and long-term periods. It is thus possible to develop a context for LCA of likely and uncertain societal activities, including transportation, over these periods. Conventional LCCA is directed toward comparing competing alternative investment strategies and can involve a range of stakeholders. Of the methods available, present worth of costs is almost exclusively used in the pavement field. However, when medium- to longer-term life-cycle periods are involved, rate-of-return and cost-effectiveness formulations can be applicable. A numerical example shows how an agency can determine the internal rate of return for two investment alternatives involving different pavement designs and a life-cycle period of 50 years. In addition, a cost-effectiveness example is provided for a sidewalk network, again with a life-cycle period of 50 years. Conventional LCCA for calculating present worth of costs will undoubtedly continue to be used in the pavement field as a primary tool. However, using a rate-of-return or cost-effectiveness formulation, especially for medium- to longer-term life-cycle periods, should be given more consideration.

Cost-effectiveness of alternative investment strategies for the power sector in India: A retrospective account of the period 1997–2002

This paper focuses on the profitability of investments in the power sector in India seen from a micro-economic viewpoint followed by macro-extrapolation. We will compare the profitability of various investment strategies that serve as an alternative to the simple expansion of the generating capacity. In a system where maintenance has long been neglected, these measures also turn out to be cheaper than capacity addition and should be given preference in a period of scarcity of funds. Improvement in the use of plants and reduction of technical and non-technical losses are profitable, but these measures are not implemented enough under the present public system in India. We will then briefly link up these findings with some of our earlier works to show that these inefficiencies arise because State Electricity Boards have long relied on technical and administrative procedures that were designed during a period of expansion and not on efficiently decentralised and information-based management as should be the case in the present mature phase.

Hedge fund performance appraisal using data envelopment analysis

In this paper we apply data envelopment analysis (DEA) to evaluate the performance of hedge fund classifications. The purpose of alternative investment strategies such as hedge funds is to offer absolute returns, so using passive benchmarks to measure their performance could be ineffective. With the increasing number of hedge funds available, institutional investors, pension funds, and high net worth individuals urgently need a trustworthy efficiency appraisal method. DEA can achieve this. An important benefit of the DEA measure is that benchmarks are not required, thereby alleviating the problem of using traditional benchmarks to examine non-normal distribution of hedge fund returns. We suggest that DEA be used as a complimentary technique (or method) for the selection of efficient hedge funds and funds of hedge funds for investors. Using DEA can shed light and further validate hedge fund manager selection with other methodologies.

Maximum Drawdown

A drawdown is defined as the accumulated percentage loss due to a sequence of drops in the price of an investment. It is collected over non-fixed time intervals and its duration is also a random variable. The maximum drawdown occurring over a fixed investment horizon is a flexible measure that provides a different perception of the risk and price flow of this investment. In this article a new modeling strategy for maximum drawdown that separates its duration and severity along with suggestions of a flexible distribution from the extreme value theory for modeling the losses is proposed. Applications for the fitted distribution, which include the computation of risk measures, classification and selection of investments, as well as its use in optimal portfolio allocation, are discussed. The properties of the model-based maximum drawdown-at-risk are then analyzed and a new risk measure, the conditional maximum drawdown-at-risk, is presented. Illustrations using stock market indexes as well as insights on the connection of the fluctuations of the maximum drawdown and the volatility of the underlying return series are provided. This methodology is applicable to various alternative investment strategies as well.

Assessment of performance-driven investment strategies of distribution systems using reference networks

Distribution systems are inherent monopolies and therefore they have generally been regulated to protect customers and to ensure cost-effective operation. In the UK this is one of the functions of the Office of Gas and Electricity Markets (OFGEM). Initially the regulation was based on the value of assets but there is now a trend towards performance-based regulation. To achieve this, a methodology is needed that enables the reliability performance associated with alternative investment strategies to be compared with the investment cost of these strategies. At present there is no accepted approach for such assessments. An approach based on the concept of reference networks is proposed. The essential idea is to analyse a small number of networks that represent the real feeders of the system being considered. The main stages are: to classify the real feeders into coherent clusters, to construct a representative network for each cluster, to assess the reliability of these representative networks and to re-aggregate the results to give those for the overall system. These representative networks are then analysed repetitively for different investment scenarios and the corresponding reference networks derived. The approach can be used to assess individual companies on an absolute basis or to compare the relative performance between companies. The approach, its implementation in conjunction with a number of distribution companies, and its effectiveness when approach using the underground part of a real system are described.

Funds of hedge funds: Ethics of this black box strategy

This paper deals with the opaqueness and the ethics of reporting practices of funds of hedge funds (FOFs) by examining this increasingly popular black box alternative investment strategy. Numerous statistical reports sent out by FOFs managers to institutional investors have been examined and it has been discovered that many FOFs (a basket of hedge funds) present very basic and elementary statistics. Furthermore, the findings suggest that hedge funds do not adhere to the ethical and reporting standards to which mutual funds are subject. Better ethical reporting standards should be established. In addition, advanced quantitative and qualitative techniques on behalf of hedge fund managers should be introduced to properly assist and educate institutional investors as well as pension fund managers in making appropriate choices on behalf of their investors.

Benefits and Risks of Alternative Investment Strategies

Benefits and Risks of Alternative Investment Strategies

Benefits and risks of alternative investment strategies

As a result of the complex trading strategies they implement, and the full flexibility they have with respect to their ability to use derivatives and trade in illiquid markets, hedge fund managers, even those following zero-beta non-directional strategies, are exposed to a variety of risk factors (volatility risk, liquidity risk, credit risk, etc) in a potentially complex manner. This paper argues that a proper understanding of hedge fund risk extends much beyond a straightforward measure of linear exposure to market risk, and provides a detailed analysis of how modern portfolio theory allows the presence of these rewarded sources of risk to be accounted for when assessing the performance of hedge fund managers. The contrasted exposures of hedge fund managers to a large number of risk factors poses serious challenges to the investor, as it requires the use of appropriate techniques dedicated to their measure and control. In contrast, it is argued that this is also the driving force behind the diversification benefits investors enjoy when investing in hedge funds. The main message can be summarised as follows: the benefits and risks or alternative investment strategies are two facets of the same coin.

An empirical examination of the effectiveness of dollar-cost averaging using downside risk performance measures

Some studies find the dollar-cost averaging investment strategy to be sub-optimal using a traditional Sharpe ratio performance ranking metric. Using both the Sortino ratio and the Upside Potential ratio, we empirically test four investment strategies for alternative asset investments. We find the relative ranking of dollar-cost averaging remains inferior to alternative investment strategies. (JEL G1, G11, N2)

Anson on Alternatives

As CIO of the world's largest public pension fund, Mark Anson, Ph.D., CFA, has learned—sometimes the hard way— that the activities of the California Public Employees' Retirement System (CalPERS) make news. Still, under Anson's energetic leadership, CalPERS has successfully ventured into a variety of alternative investment strategies—LBOs, hedge funds, CDOs, traditional (not toxic) PIPEs, and mezzanine debt, just to name a few. In this question-and-answer style piece, Anson shares his perspective on opportunities in real estate and private equity, and discusses the potential for another big hedge fund blowup.

Risk measurement and management of defined benefit pension schemes: a stochastic approach

The traditional actuarial valuation for defined benefit pension schemes operates on the basis of a set of deterministic calculations combined with actuarial judgment. It has played an important role in guiding decision‐making as far as the level of funding is concerned. The paper argues that stochastic methods can add value in certain crucial areas, in particular the financial risk management of such schemes. The traditional approach to risk is to incorporate margins in the valuation assumptions; however, a stochastic approach allows the user to evaluate specific and quantifiable risk and performance measures in respect of alternative funding and investment strategies. The paper introduces a framework that measures the risks inherent in asset allocation and contribution rate decisions, allowing decisions to be made on a more informed basis. In doing this, we suggest and apply some potential risk and performance measures. This framework provides the means to explore the trade‐offs involved in possible contribution and asset allocation decisions and leads to decision strategies that are expected to give improved outcomes for the same level of risk. A realistic case study is used to illustrate the properties of the methodology and how it might be used.

Managing Risk in Alternative Investment Strategies

In this section, the recently published book Managing Risk in Alternative Investment Strategies: Successful Investing in Hedge Funds and Managed Futures is reviewed.

The Mortality of Funds of Hedge Funds

The author applies data envelopment analysis (DEA) and uses the basic, cross-evaluation, and super-efficiency models to evaluate the performance of the fund of hedge funds classification (a basket of hedge funds). The purpose of alternative investment strategies such as funds of hedge funds is to offer absolute returns, so using passive benchmarks to measure their performance may be ineffective. With the ever-increasing number of funds of hedge funds, there is an urgency to provide money managers, pension funds, and high-net-worth individuals with a trustworthy appraisal method in ranking their efficiency. DEA can achieve this, and one important benefit of this measure is that benchmarks are not required, thereby alleviating the problem of using traditional benchmarks to examine non-normal returns. This article aims to investigate funds of hedge funds and to identify the funds that have achieved superior performance or, in other words, have an efficiency score of 100 in a risk/return setting.