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Financial Risk Management

VaR – Good for a Manager, But Bad for the Markets as a Whole – Call it the “Paradox of VaR Risk Management”

So if there’s a big market sell-off and as a response the VaR overreacts and shoots up, then many investors are kind of forced to sell because they have to stay within their VaR limits and this selling will then be done in an already collapsing market…rigorous use of VaR measures undermines the stability of markets.

It’s the type of risk management practice that works well as long as it is not needed; just like Bernanke observed after the credit crisis about their standard models that proved to be “successful for non-crisis periods”. 

-Harold de Boer Transtrend
Opalesque Roundtable series ’17 Netherlands

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Risk Parity With Strong Performance, Yet Global Macro – Managed Futures May Be a Better Choice to Offset Mispricing Risk

The positive performance of risk parity products has been sneaking up on clients after poor returns in 2015. This long-only product have done much better than many other multi-asset hedge fund strategies in the last year with the HFR 12% vol institutional index being up 9.46% through September; however, it has been riding the wave of asset price mispricing or overvaluation.

Decision-Making

Formal or Informal Predictive Procedures – If it is Repetitive, Go with the Formal Approach

The human brain is an inefficient device for noticing, selecting, categorizing, recording, retaining, and manipulating information for inferential purpose.- W.M. Grove and P.E. Meehl

If those are all the things that the human brain is inefficient with, what is left over? A lot, but there has to be focus on using the brain for the right problems and when to change the thinking process. 

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Curiosity – There Is More Than One Type and Hedge Fund Managers Need Them All

What makes a good investment manager? One trait not often talked about is curiosity. You cannot find new or unique opportunities if you are not curious; however, the concept or meaning of curiosity for investment management may be hard to define.

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Understanding Investor Preferences Is Not Easy – Just Ask Them

The line between recent “exotic preferences” and “behavioral finance” is so blurred that it describes academic politics better than anything substantive.                                 – John Cochrane University of Chicago 

John Cochrane, as well as others in finance, has focused on the academic issue of defining preferences for investors at an abstract level, but the issue becomes a reality when trying to extract preferences from investors to help build a portfolios.

Alternative Investment Strategy

Time Series or Cross Sectional Momentum – Which is Better? Your Choice May Matter

The marketplace is abuzz with the value of momentum trading, but a closer inspection shows that it is packaged in two major strains, time series and cross-sectional momentum. The traditional trend-following CTA focuses on time series momentum while the most of the equity research and implementation is conducted through the cross-sectional approach. There is similarity between these approaches, but there are also enough differences so that the return profile for each will not be the same. 

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If You Take Away the Fed Balance Sheet, Should the Bond Premium Be Negative? Term Premium Reality

The Wall Street talk is that all markets are over-valued, yet any valuation has to be placed in context. For fixed income, this is not easy given you have to make a judgment on both the real rate of return and expected inflation. Additionally, there is a need to measure the term premium associated with bonds. The premium measures the compensation necessary for investors to hold longer duration bonds versus a series of successive short bonds given the volatility and uncertainty associated with real rates and inflation. The term premium is not directly observable and is difficult to measure but has intuitive appeal.

Global Macro

Renaissance in Global Macro – It Is All About Global Disruption and “Creative Destruction” – Here Is One Avenue for Dislocation

Barron’s published a provocative piece from my friend John Curran, The Coming Renaissance of Macro Investing: The petrodollar system is being undermined by exponential growth in technology and shifting geopolitics. Coming: a paradigm shift.  The concept behind this regime shift or dislocation ties together finance, technology, and global trade. Changes in the flow of trade based on shifting patterns of economic growth with disruptions in technology are going to spill-over to financial markets and prices.  Capital flows are reactive to broader movements in power, politics, economic growth, and trade.

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Zhou Xiaochuan – The Central Banker Even Quants Should Have Known. But Who Will Come Next?

You have heard of Yellen (Fed), Draghi (ECB), Kuroda (BoJ), and Carney (BOE), but most cannot name any China central banker, yet the moves of this bank may be more important than the four when thinking about the future of world currency hegemony. Zhou Xiaochuan has been in the news just before the Chinese Congress with a strong appeal for financial reform. This is reform for further ascent of China as a major financial player. He has followed this path across his central banking career, but he is set to retire in January.

Alternative Investment Strategy

Diversification Beyond 60/40: A Path to Improved Portfolio Performance

“Enough with this diversification talk, I’ve got my 60/40 and I am happy!” The 60/40 stock/bond portfolio mix has become a standard reference or benchmark for many investors, yet its performance versus a truly diversified portfolio is mixed.

Economics

Richard Thaler – Nobel Prize Winner – The Economist Who Provides a Foundation for Rules-Based Managed Futures

We congratulate Richard Thaler on winning this year’s Nobel Prize in Economics. His relentless research on the failings of rational behavior in human decision-making has had a significant impact in finance and economics. His prolific work is the foundation for all of what we call behavioral economic and finance. Prior to Thaler, economist focused on Homo Economicus, the rational man that does not make mistakes or misjudgments. Thaler showed through test after test that we make mistakes and have biases. He did this albeit radical work not as an outsider to finance like Dan Kahneman but as a economist steeped in the neoclassical tradition.

Alternative Investment Strategy Managed Futures

Back to Basics on Managed Futures with AIMA – Answering the Question for Why This Strategy Should be Held

There are many works on managed futures that explain the basics of this hedge fund strategy, but the characteristics need to be reinforced especially at current times when the strategy is underperforming other hedge fund strategies. The core reason for holding managed futures is that it provides useful diversification. This diversification is not available from other strategies and this diversification will be especially present during ‘bad times” of a equity decline. Don’t forget that those strategies that have more systematic risk will need to generate higher returns. Investors will be paid to hold them. On the flip-side, there will be a “payment” for managed futures which does well in “bad times”.

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Is there a difference between smart and intelligent with hedge fund management?

An investor can ask, “Find me the most intelligent hedge fund manager. Someone else may say, “I want the smartest manager in the hedge fund space”. Saying that you want an intelligent manager may not be the same as saying you want a smart manager. There is a difference between intelligence and smarts, so says, Heather Butler in the recent Scientific American article, “Why do smart do dumb things, Intelligence is not the same as critical thinking and the difference matters”.

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