AIMA

The Alternative Investment Management Association

Alternative Investment Management Association Representing alternative asset managers globally

You are:

The emerging role of crisis alpha investing

Kathryn M. Kaminski, PhD

CME Group

Q2 2012

Q2 edition

 


As more and more market participants make the leap further and further into alternative investments, it is paramount that they understand what to expect going forward and what types of new risks they may need to be aware of. Unfortunately for many investors, promises of uncorrelated returns have been hard to come by and investors are scratching their heads wondering what to do next.

 

Diversification and alpha beta separation

If we go back to founding principles in the alternative space, we can outline the paradigms which ground investment decisions we see today. Going back to basics, portfolio management is about diversification and balancing risk and reward. Similar to CAPM theory, diversification works because as you add more and more uncorrelated or less correlated assets the idiosyncratic or diversifiable risks can be reduced. Balancing risk and reward requires investors to allocate to a set of risk factors while attempting to maximize their return given a prescribed level of risk. The alpha beta separation suggests that investment strategies can be divided into alpha and beta drivers. Returns from alpha drivers are focused on absolute return with hedged systemic risks. On the other hand, beta drivers are about earning risk premiums with exposure to systematic risk. Absolute return strategies, given their tantalizing moniker, fit perfectly into this strategy where in the modern days of portfolio allocation, systematic risks can be accessed cheaply while absolute return vehicles can pump up total return with “seemingly” little impact on total risk.

 

Send in the tails

Most alternative investment strategies use carefully constructed investment strategies which, often but not always, involve leverage. They invest in assets with varying levels of liquidity and sometimes complex networks of counterparties including both their brokers and fund investors themselves. Each and or any of these characteristics can catch normally very solvent and well thought out strategies in the heat of the moment and especially during a moment of financial crisis. This structural set-up for hedge funds makes risks in hedge funds increasingly more about tail risk.

Recent research in hedge funds in crises demonstrates that many hedge funds are holding common latent idiosyncratic risks in credit, liquidity, and volatility (see Billio, Getmanksy and Pelizzon 2010). These risks may be linked to issues related to liquidity, complex counterparty network effects, funding liquidity, rapid redemptions, and margin death spirals. As most risk measurement techniques are based on divergent approaches unfocused on structural issues, they may miss these potential risks. This point highlights the fact that, just like the term hedge, hedge fund risks are more about “magnified basis risks” and/or tail risks. These risks, if not properly accounted for, can result in a lack of diversification and a lack of alpha beta separation. Put simply, naïve diversification in the alternative space can lead to increased idiosyncratic risks while tail risks may deem so called absolute return strategies less than absolute.

 

Where are you holding your tail?

Lackluster performance in many alternative strategies has sent this message to investors. The only remaining question investors are asking is what to do about tail risks? The key of course, is in going back to basics. If you really want diversification in your portfolio, find investments that like crisis and volatility. Investors need to focus on deciding if they want to pay insurance premiums for the next financial apocalypse or try to find alternative strategies which may be able to deliver “crisis alpha” when their portfolios truly need it.

 

www.cmegroup.com/kaminski

 


 

Back to Listing

Main Menu

  1. Home
  2. About
    1. Our Core Objectives
    2. Meet the team
    3. AIMA Council
    4. Global Network
    5. Sponsoring Partners
    6. Opportunities at AIMA
    7. AIMA’s 25th anniversary in 2015
  3. Join AIMA
    1. Benefits of Membership
    2. Membership Fees
    3. Application form
  4. Members
    1. AIMA DDQs
    2. AIMA Annual Reports
    3. AIMA Governance
    4. AIMA Logo
      1. Policy note
    5. AIMA Members' List
    6. AIMA Review of the Year
    7. Committees and Working Groups
    8. Weekly News
    9. Update Profile
  5. Investors
    1. AIMA Investor Services
    2. AIMA Members' List
    3. Investor Steering Committee
  6. Regulation
    1. Asset Management Regulation
      1. EU Asset Management Regulation
        1. AIFMD
        2. European Capital Markets Regulation
        3. MiFID / MiFIR
        4. UCITS
        5. European Venture Capital Directive
        6. Shareholder Rights Directive
        7. European Long Term Investment Fund Regulation
        8. Loan Origination Funds
        9. Capital Raising
        10. AIFMD-Related Events
      2. US Hedge Fund Adviser Regulations
        1. Registration and Reporting
        2. Incentive-Based Compensation
        3. JOBS Act
      3. Asia Pacific Asset Management regulation
      4. Other Jurisdictions’ Asset Management Regulation
      5. Private Placement Regime
        1. Canada
        2. Dubai
        3. Finland
        4. Germany
        5. Hong Kong
        6. Japan
        7. Saudi Arabia
        8. Sweden
        9. United Arab Emirates
      6. Systemically Important Financial Institutions ('SIFIs')
      7. Remuneration
        1. UK
        2. United States
        3. CRD IV and CRR
        4. AIFMD
        5. MiFID
      8. Shadow Banking
      9. Volcker Rule
      10. Other
      11. Systemic Risk Reporting
      12. Dealing Commission
      13. Corporate Governance
      14. Securitisation
    2. Markets Regulation
      1. Algorithmic and High Frequency Trading
        1. EU Automated Trading
        2. US Automated Trading
      2. Benchmarks
      3. Capital Markets Union
      4. Derivatives/Clearing
        1. BCBS - IOSCO
        2. EMIR
        3. Dodd-Frank Act Title VII
        4. Hong Kong
        5. MiFID II / MiFIR - Derivatives
        6. Singapore
      5. Market Abuse
      6. MiFID II / MiFIR
      7. Position Limits
        1. MiFID II - Commodities
        2. CFTC Position Limits
      8. Recovery and Resolution
        1. EU
        2. CPSS-IOSCO
        3. Financial Stability Board
      9. REMIT
      10. Securities Settlement
      11. SFT reporting & transparency
      12. Short Selling
    3. Tax Affairs
      1. Automatic Exchange of Information (AEOI)
        1. FATCA
        2. EU - AEFI
        3. OECD - Global Standard on AEFI
      2. Australia - Investment Manager Regime (IMR)
      3. Base Erosion - Profit Shifting (BEPS)
      4. FIN 48 and IAS 12
      5. Financial Transaction Tax (FTT)
      6. UK Investment Management Exemption (IME)
      7. UK Offshore Funds Regime
      8. Other
    4. AIMA's Policy Principles
    5. Search
    6. Resources
      1. Guidance Notes
      2. Jurisdictional Guides
      3. Noticeboard
        1. AEOI: FATCA and other regimes
        2. AIFMD
        3. Algorithmic and High Frequency Trading
        4. Bank/Capital Regulation (including NSFR)
        5. BEPS
        6. CFTC Registration and Exemptions
        7. Corporate Governance
        8. Dealing Commission
        9. Derivatives
        10. FTT
        11. MiFID / MiFIR
        12. Other Hot Asset Management Topics
        13. Other Hot Markets Topics
        14. Other Hot Tax Topics
        15. Position Limits
        16. Trading
        17. UCITS
        18. UK Partnership Tax Review
        19. US State and Local Taxes
        20. Volcker Rule
      4. Hedge Fund Manager Training
      5. Quarterly Regulatory Update
      6. Webinar Programme
      7. Regulatory Compliance Association
        1. About the Regulatory Compliance Association
        2. RCA Curricula and initiatives for alternative investment firms
        3. Meet the regulators and Sr. Fellows
  7. Education
    1. Research
      1. AIMA Research
      2. Industry research
      3. Surveys
        1. 2016 Global Hedge Fund Survey with KPMG and the MFA
        2. Liquidity Pulse Check
        3. Private Credit
    2. AIMA Journal
      1. Recent issues
      2. Search AIMA Journal articles
      3. AIMA Journal archive: 2010-2012
    3. '25 Years in Hedge Funds'
      1. Introduction - AIMA's global mantra
      2. How the hedge fund industry has evolved over the last 25 years
      3. How the regulatory landscape has changed for hedge funds
      4. Separating fiction from reality: The most common and persistent hedge fund myths
      5. The next five years - where is the hedge fund industry headed?
      6. Virtual roundtable - Leading figures from the hedge fund industry look ahead to 2020
      7. Learning the lessons from the past
      8. Accessing hedge funds: how ‘solutions’ are the new FoHFs
      9. 'Big data': The growth of the global hedge fund industry
    4. "The Case for Hedge Funds"
      1. Global Hedge Fund Industry Paper: The value of our industry
      2. The Value of the Hedge Fund Industry to Investors, Markets and the Broader Economy: Research commissioned by AIMA and KPMG
      3. The Evolution of an Industry: KPMG/AIMA Global Hedge Fund Survey
      4. Contributing to Communities: A global review of charitable and philanthropic activities by the hedge fund industry
      5. Beyond 60-40: The evolving role of hedge funds in institutional investor portfolios
      6. The Cost of Compliance: Global hedge fund survey by AIMA, MFA and KPMG
      7. Capital Markets and Economic Growth: Long-term trends and policy challenges
      8. Apples and Apples: How to better understand hedge fund performance
      9. The Extra Mile: Partnerships between hedge funds and investors
      10. Key articles by AIMA on the case for hedge funds
    5. AIMA Guides to Sound Practices
    6. AIMA guides for institutional investors
    7. Transparent, Sophisticated, Tax Neutral - The Truth About Offshore Funds
    8. CAIA Association pages
      1. Fundamentals of Alternative Investments
    9. Regulatory Compliance Association pages
      1. About the Regulatory Compliance Association
      2. RCA Curricula and initiatives for alternative investment firms
      3. Meet the regulators and Sr. Fellows
    10. Certified Investment Fund Director programme
    11. Services to Start-up Managers
    12. Glossary
    13. Cyber Security Resources
  8. Events
    1. AIMA Events
      1. AIMA Annual Conference
        1. 2015 Conference - Agenda
        2. 2015 Conference - Charity Dinner
        3. 2015 Conference - Videos
      2. AIMA's Global Policy and Regulatory Forum
        1. 2016 Forum
          1. 2016 Forum - Agenda
          2. 2016 Forum - Speakers
          3. 2016 Forum - Sponsors
          4. 2016 Forum Supporting Organisations
          5. 2016 Forum - Review
    2. AIMA webinars
    3. Industry events
  9. Media
    1. Press Releases & Statements
    2. AIMA's blog
    3. Media Coverage
      1. Articles by AIMA
        1. Archive
      2. AIMA in the news
      3. Video interviews
      4. Industry news
    4. Media Contacts
    5. Press Materials
    6. Photos of Jack Inglis

Sub Menu

  1. Research
    1. AIMA Research
    2. Industry research
    3. Surveys
      1. 2016 Global Hedge Fund Survey with KPMG and the MFA
      2. Liquidity Pulse Check
      3. Private Credit
  2. AIMA Journal
    1. Recent issues
    2. Search AIMA Journal articles
    3. AIMA Journal archive: 2010-2012
  3. '25 Years in Hedge Funds'
    1. Introduction - AIMA's global mantra
    2. How the hedge fund industry has evolved over the last 25 years
    3. How the regulatory landscape has changed for hedge funds
    4. Separating fiction from reality: The most common and persistent hedge fund myths
    5. The next five years - where is the hedge fund industry headed?
    6. Virtual roundtable - Leading figures from the hedge fund industry look ahead to 2020
    7. Learning the lessons from the past
    8. Accessing hedge funds: how ‘solutions’ are the new FoHFs
    9. 'Big data': The growth of the global hedge fund industry
  4. "The Case for Hedge Funds"
    1. Global Hedge Fund Industry Paper: The value of our industry
    2. The Value of the Hedge Fund Industry to Investors, Markets and the Broader Economy: Research commissioned by AIMA and KPMG
    3. The Evolution of an Industry: KPMG/AIMA Global Hedge Fund Survey
    4. Contributing to Communities: A global review of charitable and philanthropic activities by the hedge fund industry
    5. Beyond 60-40: The evolving role of hedge funds in institutional investor portfolios
    6. The Cost of Compliance: Global hedge fund survey by AIMA, MFA and KPMG
    7. Capital Markets and Economic Growth: Long-term trends and policy challenges
    8. Apples and Apples: How to better understand hedge fund performance
    9. The Extra Mile: Partnerships between hedge funds and investors
    10. Key articles by AIMA on the case for hedge funds
  5. AIMA Guides to Sound Practices
  6. AIMA guides for institutional investors
  7. Transparent, Sophisticated, Tax Neutral - The Truth About Offshore Funds
  8. CAIA Association pages
    1. Fundamentals of Alternative Investments
  9. Regulatory Compliance Association pages
    1. About the Regulatory Compliance Association
    2. RCA Curricula and initiatives for alternative investment firms
    3. Meet the regulators and Sr. Fellows
  10. Certified Investment Fund Director programme
  11. Services to Start-up Managers
  12. Glossary
  13. Cyber Security Resources