Adaptive Investment Approach
Henry Ma

During the last decade, two deep bear markets (results of the high tech bubble and the subprime mortgage crisis) have challenged conventional wisdom in finance, including modern portfolio theory (MPT) and the efficient market hypothesis (EMH). As an alternative to these traditional viewpoints, the adaptive markets hypothesis (AMH) proposed by Professor Andrew Lo of MIT Sloan School of Management helps to explain the importance of macro factors and market sentiment in driving asset returns. This article examines some of the shortcomings of MPT and the EMH and introduces the framework of the adaptive investment approach, under which investors can adjust their investments to reflect economic regimes, ongoing market returns, or market volatility. This approach has the potential to deliver consistent returns in any market environment by dynamically taking positions in the financial assets that are perceived as likely to have the best returns given current market conditions.

 

Kathryn Kaminski, CAIA, on Trend Following with Managed Futures
Kathryn Kaminski

AIAR interviews CAIA Member Kathryn Kaminski about her new book, Trend Following with Managed Futures: The Search for Crisis Alpha (co-authored with Alex Greyserman).

 

Comparing Three Generations of Commodity Indices: New Evidence for Portfolio Diversification
Philipp J. Kremer

Increased investment in the commodity markets has challenged the reported diversification benefits of commodities and triggered investment firms to improve the methodology behind their indices. As a result, investors must consider three different generations of commodity indices; the question is, “Which index still provides diversification benefits?” This article addresses this question for traditional U.S. investors by considering seven commodity indices from May 1991 to June 2013, covering all three generations. Using spanning tests, the research results show that the first generation indices no longer provide benefits in portfolio diversification. Evidence for the second generation indices is mixed, while the third generation indices still offer improvements with regard to portfolio diversification.

 

Beyond Venture Capital: An Innovative Approach for Investment in New Ventures and Projects
Manuel Stagars, CAIA

This article introduces assimilation funds as a new approach to invest capital in startups. Instead of funding startups and hoping for extraordinary returns, an assimilation strategy recommends diversifying early stage capital across the strategic value chain of selected portfolio companies. Such an asset allocation allows investors to reap rewards when investee companies perform strongly, while capping downside risk through diversification and collateral. This article provides the underlying theory of these financial instruments, their asset allocation, and their return characteristics. It shows how the approach is helpful for venture capital firms and other investment firms. Finally, it compares the approach to traditional venture capital practices, and points out its advantages and disadvantages from different viewpoints.

 

Procyclical Behavior of Hedge Funds: A Portfolio Manager and Investor’s Perspective
François-Éric Racicot and Raymond Théoret

In this article, the authors study the procyclical behavior of hedge funds in relation to the portfolio manager and the investor—an often-neglected topic in hedge fund literature. Using spectral analysis, they show that hedge fund returns display fluctuations at the business cycle frequency and that these spectra are quite different from those of the market portfolio. This suggests that hedge fund returns are predictable to a certain degree. The authors continue with a study of the cyclical behaviour of alpha and beta, finding that hedge fund managers tend to increase their beta, and thus their leverage, in expansionary periods and to deleverage during recessions. The study concludes with a cross-sectional measurement of diversification showing that good diversification opportunities in the hedge fund industry continue to exist, particularly during times of recession.

 

The Hedge Fund Conundrum: Are Funds Meeting Investor Expectations or Not?
Kevin Mirabile

How is it that one day the headlines are filled with cautions over unmet expectations from hedge fund investments and the next day we hear about record inflows and proclamations of $3 trillion in AUM by year-end? Some institutions have been disappointed by the performance of hedge funds, while others are highly optimistic about adding hedge funds to their portfolios. While these views represent extremes in the investor spectrum, understanding this contradiction is useful for investors. The world of finance rarely stands still and expectations and analytical tools need to evolve to approach and address the current environment effectively.

 

IR&M Momentum Monitor
Alexander Ineichen, CAIA

Risk is often defined as exposure to change. Spotting change, therefore, is important. There are essentially three approaches to change: 1. Displaying complete ignorance, 2. Having a wild guess as to what it means, or 3. Measuring it in a systematic fashion with an applicable methodology and adapting to it. The author recommends choice number 3. Momentum can be perceived as a philosophy. The author discusses the Momentum Monitor (MOM) and recommends it as a risk management tool. If risk is defined as “exposure to change,” then one ought to spot the change.

 

VC-PE Index
Mike Nugent, Mike Roth

Private equity returns improved in Q2 2014 with venture capital continuing to reward its investors who stuck with them after the dotcom crash. Bison’s Momentum indicator moderated slightly in Q2 2014, which could indicate valuation increases will be slowing down over the coming quarters.

 

The IPD Global Intel Report
Max Arkey

Drawing from IPD Global Intel, which tracks the performance of 80,000 commercial properties worth in excess US $2.0 trillion, MSCI Real Estate Market Insights provide regular commentary on 33 national markets. In this release, the UK is featured, and we analyze the market from four key positions; performance, risk, strategy, and asset management. We contrast increasing momentum in the UK with total returns in neighboring European markets, and highlight significant variations in performance across UK cities. Pricing and other market risks are reviewed as the UK has historically been one of the most volatile places for real estate capital. The strategy to invest heavily in London versus secondary UK markets and the choice of property type has top-down ramifications for both performance and risk, which are reviewed. Finally, asset management KPI’s are dissected, and we find rental values in the UK are still lagging their pre–financial crisis levels, leading to inflated cost ratios.