Editors’ Letter

As we near the completion of our second year of the Alternative Investment Analyst Review we are pleased to welcome Keith Black as an Editor of AIAR. Keith brings a diverse skillset to AIAR with extensive experience both as a practitioner and an academic. As we develop this issue, we find ourselves facing a slowly recovering economy, facing potential risks for rising interest rates, increasing inflation, regulatory changes, and rising energy prices. This issue of AIAR includes a variety of articles that address many of these risks.

1. Introduction

Within the universe of hedge funds and commodity trading advisers (CTAs), one of the most widely quoted measures of risk is peak-to-trough drawdown. Our experience suggests that investors do not have a widely accepted way of forming expectations about just how much managers who are in business over long periods of time might be expected to lose. Rather, we find that investors tend to monitor a manager’s worst or maximum drawdown with only informal or anecdotal information about the manager’s average annual or previous year’s returns. Drawdown as a measure of risk has failed to attract the same kind of research and attention that is devoted to other common measures, such as return volatility, VaR, or Sharpe ratios.

1. Introduction

With interest rates in most of the developed countries near zero in nominal terms and negative in real terms, investors increasingly are looking for ways to protect their capital against the erosion of purchasing power as well as unexpected changes in interest rate term structure and inflation. One approach that may help to accomplish this objective is increasing the allocation to real assets.

1. Introduction

In light of the importance of crude oil to the world’s economy, it is not surprising that economists have devoted great efforts towards developing methods to forecast price and volatility levels. While the most popular forecasting approaches are based on traditional econometrics, computational approaches such as artificial neural networks and fuzzy expert systems have gained popularity in financial markets because of their flexibility and accuracy. However, there is still no general consensus on which methods are more reliable.

1. Introduction

Inflation hedgers worldwide can be divided between those that are compelled by law or contract to do so and those who choose to do so as an investment strategy. In the first category we find institutional investors such as British pension funds, that must offer pensioners a guaranteed real value for their retirements. In the second category we find their American peers who choose to offer real return targets to their investors. In practice, we find a collection of investors between these extremes who are partly driven by imperative and partly driven by strategy. This last category includes French retail banks hedging their inflation-linked retail savings products or insurers that offer policies that, by law, are guaranteeing real values. As both of these cases involve exposure to short-run inflation liabilities, the firms have the option not to fully hedge this inflation exposure and keep the risk on their books. This combination of imperative and strategic decisions has generated a massive influx of money into inflation hedging assets which could be defined as too many dollars chasing too few (securities). This steady increase in the demand for inflation hedging assets as inflation remains modest begs for an explanation.

1. Introduction

The world of derivatives as we know it is in a state of flux. Prior to the credit crisis, the derivatives game was played on two very different fields: over-the-counter (OTC) derivatives were traded via dealer networks and exchange-traded derivatives (ETD) were traded via centralized clearing houses. Although in theory the nature of derivatives contracts should be roughly the same, in application, the rules as well as the mechanism by which these contracts change hands, varied substantially. The financial crisis that unfolded in 2008 led to a sharp review of the way derivatives contracts are traded and collateralized. In an attempt to level the playing field and create a more cohesive approach to regulating derivatives markets, legislation such as the Dodd-Frank Act in the U.S. and EMIR in Europe spearhead the re-structuring and reorganization of the way that the derivatives game will be played.