CAIA Members get exclusive access to the latest thinking and practices in alternatives.

You Could be Wrong Even When You are Right!
Hossein Kazemi

Suppose you discover an asset that has been losing money since inception (e.g., a mutual fund run by an incompetent manager). Further, you have every reason to believe that the asset will continue to lose money going forward. You wonder how good it would be if you could short this mutual fund. You could not only make some money but also help bring some discipline to the market, removing incompetent fund managers from the market. Well, today is your lucky day, and the SEC has announced that ETFs and inverse ETFs based mutual funds can be created. You immediately call your broker and take a $1,000,000 position in the inverse ETF tracking the fund. The inverse ETF is guaranteed to match the period return on the fund but in opposite direction. So there will be no basis risk – if the fund is down 1% tomorrow, the inverse ETF will be up 1%. Even better, your broker tells you that there is absolutely no cost to buying the inverse ETF, and the broker is even willing to waive its fees. Can it get any better, you think. Yes, it can.

The MSCI Global Intel Report
Max Arkey, MSCI Real Estate

Two roads lead asset owners into real estate: the private (direct and indirect) ownership route and the public equity route. With private assets, investors can analyze performance in detail, down to the asset and vehicle level. However, listed real estate, which includes public Real Estate Investment Trusts (REITs), rarely offers that level of data, making it very difficult for asset owners to monitor a seamlessly integrated portfolio consisting of both private and public assets. This article looks at the divergence and assesses two key developments in the field of real estate investment.

 

Introductory Guide to Investing in Private Equity Secondaries
Jochen Mende, Joseph B. Marks, Kairat Perembetov Capital Dynamics

Investors are facing a historically difficult macro environment with significant headwinds felt across various asset classes, impacting return targets. Interest rates are at unprecedented low levels, leading to scant returns for the safest assets and significant principal risk to fixed income returns. Equity markets are trading well above long-term averages exposing investors to downside risk. Additionally, actuarial targets are being significantly lowered, causing balance sheet liabilities to rise at institutionally managed portfolios. Finally, market volatility, which has been exceptionally low in recent years, has increased in the last few months implying pressure on equity returns ahead. Faced with the dual challenges on both the asset and liability fronts, investors today have an increasingly difficult task and are looking into "alternatives", including private equity secondaries ("secondaries"). In this article, the authors suggest that private equity secondaries present an excellent risk-adjusted return profile, exhibiting defensive attributes while still providing attractive long-term returns.

 

The Persistence of Smart Beta
Hamish Preston, Tim Edwards, Craig Lazzara, S&P Down Jones Indices

The notion that patterns in securities prices can be predicted and exploited has given rise to at least two industries: quantitative fund management and, more recently, the index-based alternative operating under the ambitious moniker “smart beta.” The performance of such systematic strategies poses a challenge to the “efficient” markets of classical theory, and has therefore produced a third cottage industry for academics—alternatively quantifying, explaining, or refuting the strategies’ supposed outperformance. This paper explores the implications and challenges for investors who are interested in extrapolating the past into the future.

 

New Evidence on Whether Gold Mining Stocks Are More Like Gold or Like Stocks
Mark A Johnson, Douglas J. Lamdin, Loyola University Maryland, University of Maryland

In this article the authors examine the returns of gold mining stocks, gold, and a diversified portfolio of U.S. stocks over a period from 2006 to 2015. They find that the return on gold mining stocks is explained more by the return on gold than by the return on stocks. Because gold mining stocks are more like gold than like stocks, this suggests that gold mining stocks may be viewed as a substitute for gold in a diversified portfolio. The return on gold, however, is far less correlated with the stock market return than is the return on gold mining stocks. This implies that for risk reduction purposes, gold is preferred to gold mining stocks.

 

Assessing Risk of Private Equity: What’s the Proxy?
Alexandra Coupe, PAAMCO

Asset allocation is perhaps the most important choice facing CIOs. It involves evaluating the risk/return profile of various asset classes and is usually based on a combination of forward-looking expected returns and risk measures derived from historical data. In this context, the traditional modeling of private equity is subject to significant drawbacks. Available index data for private equity is lagged, smoothed, and understated with respect to the beta, volatility, and correlation with public equities. These drawbacks can have a significant impact on portfolio allocation decisions when a large share of a portfolio is allocated to private equity. The purpose of this article is to evaluate alternative methods to proxy private equity investments in the context of portfolio allocation. This assessment draws on PAAMCO’s experience in managing hedge fund portfolios, which may contain private equity positions.

 

Understanding the Kelly Capital Growth Investment Strategy
Dr. William T. Ziemba

The Kelly capital growth investment strategy maximizes the expected utility of final wealth with a logarithmic utility function. In 1956, Kelly showed that static expected log maximization yields the maximum asymptotic long run growth. The classic application of the Kelly strategy and fractional Kelly strategies, which blend cash with the full Kelly strategy, typically involves situations where many similar investments are repeated; the game of black jack being a primary example, although it also applies to investments. Many top investors and hedge fund managers, including John Maynard Keynes, Warren Buffett, George Soros, Ed Thorp, and Jim Simons have used these types of strategies. This article covers the basic details of the Kelly capital growth criterion and how it can be employed in finance today.

 

Hedge Fund Investing: A Conversation with Kevin Mirabile
Barbara J. Mack

Kevin Mirabile is a clinical assistant professor of finance at the Gabelli School of Business, Fordham University, where he teaches courses on the principles of finance, alternative investing and hedge funds. He is also on author of a book on hedge fund investing. His book, Hedge Fund Investing: A Practical Guide to Investor Motivation, Manager Profits and Fund Performance (Second edition, 2016). CAIA had a chance to speak with Professor Mirabile this summer about his perspective on hedge funds, where the jobs are for young people, and how the CAIA program fits in to the picture at Fordham.

 

Dynamic Asset Allocation as a Response to the Limitations of Diversification
Thomas Zimmerer,Ph.D, Taylor Carrington, Allianz Global Investors

Institutional investors have to meet challenging goals—above all, achieving a high return target with limited drawdown risk. Yet in the current environment, reaching that objective has become increasingly difficult. This article explores how using risk- mitigation strategies based on dynamic asset allocation may provide investors with a smoother, more relaxed journey toward their goals, and in a cost-effective way.

 

Bison Global Benchmarks
Mike Nugent and Mike Roth, Bison

The median TVPI metrics for North American All PE increased by less than 2% over the last four quarters ended in Q4 2015. North American venture capital’s median TVPI metrics grew at a faster pace than their buyout brethren in seven of eight vintage years from 2005 – 2012.