While the Edhec Risk and Asset Management Research Centre is bigger, smarter and better–connected than AllAboutAlpha.com, both organizations share the same genetic blueprint. Edhec’s Lionel Martellini confirmed this fact this morning in his introduction to day two of the university-affiliated organization’s annual hedge fund conference in London. Edhec sees alternative investments as a (the) central issue in institutional portfolio management and believes that we need stronger links between research and practice.

Some would say that this overstates the importance of emerging asset classes. But Martellini points to two unique aspects of alternative investments that are fundamentally unique: non-normality and data integrity. The introduction of higher moments such as skew and kurtosis le to an explosion of data since correlation was now joined by co-skew and co-kurtosis. These co-moments add exponentially to the amount of information required for portfolio construction. To compound things, monthly data that is susceptible to “smoothing” makes alternative investment research a whole new ball game for academics and practitioners.

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Most hedge fund conferences are rather staid affairs, taking place in exclusive hotels or converted castles.  In fact, one recent event was held at a hotel described by organizers as “A luxury Mayfair hotel of great repute, it embodies the highest of traditional values…”

But what do you do when your event becomes so popular it outgrows any of these traditional venues?  You move into London’s cavernous Excel Centre near London’s storied Canary Wharf.

That’s what French university-affiliated research centre Edhec has done this week for its annual “Alternative Investment Days“.   Billed as “bringing academic insights to alternative investments”, it’s a cross between the Detroit Auto Show and an academic symposium that has attracted nearly 800 hedge funds, investors and service providers this year.  AllAboutAlpha.com is a media partner of the event and we are on location in the Docklands this week to tell you what’s going on.

Edhec’s Jean-Rene Giraud kicked off the proceedings this morning with a spirited defense of the hedge fund sector.  Giraud emphasized that Edhec has never been afraid to criticize the hedge fund industry or to call it out on some of its claims.  But in an ironic twist, he says that he now feels compelled to defend the industry against what he sees as unfair attacks by those seeking a scapegoat for the current financial crisis.

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Lionel Martellini

Professor of Finance at EDHEC Graduate School of Business (since 2003) and the Scientific Director of Edhec Risk and Asset Management Research Centre.  Former member of the faculty at the Marshall School of Business, University of Southern California.

Bio/Contact Information (Edhec)
Research (SSRN)
Relevant Postings (AlAboutAlpha.com)
 

Owing in part to its tremendously prolific promotional department, few in the hedge fund industry are unaware that EDHEC Risk and Asset Management Research Centre – an off-shoot of the renowned Edhec Business School in France – is releasing its latest research on hedge fund replication today (Thursday) at a seminar in London.  The paper’s title summarizes Edhec’s take on the state of the replication world today: “The Myths and Limits of Passive Hedge Fund Replication: An Attractive Concept…Still a Work in Progress”.

While the full paper isn’t yet available to the public, our friends at Edhec have provided AllAboutAlpha.com with an copy so we can give you some of the main points. 

Overall, we find it to be a very good survey of the state of the replication field.  In the words of the authors, Noel Amenc, Walter Gehin, Lionel Martellini (Hall of Fame, related posting), and Jean-Christophe Meyfredi:

“The purpose of this position paper is to provide an in-depth analysis of the subject, with an emphasis on the findings based on the last ten years of academic research on hedge fund performance analysis and replication, and a discussion of the implementation challenges related to a commercial offering based on these concepts.”

The paper reaches two broad conclusions:

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Hedge Fund Replication: Old theory, new interest, inconclusive results

Consultant and journalist Pierre Saint-Laurent* continues his coverage of EDHEC’s Asset Management Days in Geneva this week for All About Alpha.  On Tuesday, he attended a much anticipated presentation on hedge fund replication featuring researchers Noël Amenc, Jean-Christophe Meyfredi, François-Serge Lhabitant and Walter Géhin.  Other industry leaders** joined the EDHEC group on a subsequent panel discussion. Here again is Saint-Laurent’s dispatch from Geneva.

Hedge fund replication is controversial. For some, it’s a gallant effort to lower fees, increase transparency and boost liquidity. For others, it’s a work in progress whose promoters may be getting ahead of themselves.

But one thing is for sure: Hedge fund replication is not a new subject according to EDHEC researchers. The general concept of factor modeling dates back decades, and one of its most famous applications to hedge fund returns was completed by Fung and Hsieh in their 2002 style-based research.

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A Martini with Martellini

Consultant and journalist Pierre Saint-Laurent* covers EDHEC’s Asset Management Days in Geneva this week for All About Alpha.  On Monday, he sat down with EDHEC’s Lionel Martellini to have a frank discussion about hedge fund replication in advance of Martellini’s much anticipated presentation on Tuesday.

Martellini, one of the top EDHEC researchers, is the co-author of a new study** on the topic (to be presented for the first time at the conference).  Martellini is a member of the editorial board of The Journal of Portfolio Management and The Journal of Alternative Investments. His research on quantitative asset management and derivatives valuation has been published in leading journals and featured in major dailies such as The Financial Times and The Wall Street Journal.

Pierre Saint-Laurent (PSL): Professor Martellini, thank you for meeting with All About Alpha.  In your words what exactly is hedge fund replication?

Lionel Martellini: Hedge fund replication is a set of investment approaches that hold the promise of lower fees, greater transparency, and higher liquidity while accessing alternative risk premia. The delivery of so-called “alternative beta” allows us to maintain desirable distributional asymmetries with these added benefits. At least, that’s the objective.

There are two main approaches to HF replication. The first is factor-based replication, the second is payoff distribution replication.

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By: Noël Amenc, Edhec Business School & Lionel Martellini, University of Southern California
Published: February 15, 2003

This is a complex academic paper and is tough to read.  However, beginning on page 44, professors Amenc and Martellini discuss mathematical models to determine the optimal amount of hedge funds in a “core/satellite” (i.e. portable alpha) investment approach. 

“Given that most active managers still have dominant passive exposure to their benchmark, instead of paying high fees on the passively managed part of their portfolio, the core-satellite approach suggests passively investing in a low-fee index fund (or an enhanced index product) as a core portfolio and investing in a variety of satellite active managers with higher tracking error.”

“…investors may want to invest in market-neutral managers who provide only portable alpha benefits without passive exposure to the index, so that they only compensate active managers for their abnormal returns, not for their passive exposure to rewarded sources of risk.”

“…a satellite/core approach seems to be perfectly suited for investors who attempt to use hedge funds to add portable alpha benefits to their long-only portfolio without modifying their passive exposure to a reference index…”

Surgeon-General’s Warning: take an aspirin before trying to read this paper.

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By: Noël Amenc, Philippe Malaise and Lionel Martellini, EDHEC
Published: 2005

Excerpt: 

“In this paper, “From Delivering to the Packaging of Alpha. Illustration from Active Bond Portfolio Management: Using Fixed-Income Derivatives to Design Hedge Fund Type Offerings that Better Fit Investors’ Needs”, the authors emphasize the need for the hedge fund industry to adopt a consumer (investor)-driven approach, as opposed to the current producer (manager) perspective, and call for the emergence of new types of offering with characteristics better suited to the needs of institutional investors. Using active bond portfolio management as an example, they present evidence that derivatives can be used by managers not only for generating and delivering abnormal performance, but also for packaging such performance in a form that is consistent with the modern core-satellite approach to institutional portfolio management, for which they explore both a standard static version and also a dynamic extension allowing for dissymmetric control of active management risk.”

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