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INDEXING HEDGE FUND INDEXES
Noël Amenc, Lionel Martellini, and Mathieu Vaissié
INTRODUCTION
Recently we have observed the creation and marketing of a proliferation of hedge fund indexes that has paralleled the increased interest in hedge fund investment. Amenc, Martellini, and Vaissié (“AMV”) examine these indexes and show us why all hedge fund indexes are not created equal.
AMV identify large differences among indexes in reported performance for the same time period. They also find correlations with various benchmarks vary wildly among indexes. As a result, identifying the “best” index presents a significant problem for assessing individual hedge fund performance and for asset allocation decisions.
AMV document how the differences among indexes can be traced to differences in their construction methods, differences in their constituent funds, and differences in the impact of well-known biases (discussed in several papers in this volume) that affect measured returns in hedge fund indexes.
AMV suggest that the best index may in fact be a combination of several individual indexes. That is, it may be best to employ multiple indexes to construct a super strategy-based index.
They implement this approach using Principal Component Analysis. In this way, they extract the primary driver of variability across competing indexes for a given strategy. In the process, they argue, the resulting super index is likely to have neutralized the impact of biases in measured returns, at least to the extent that those biases do not affect various indexes in a highly correlated fashion.
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BIBLIOGRAPHY
- N. Amenc, R. Faff, and L. Martellini, 2003, "Desperately Seeking Pure Style Indexes", Working Paper, Edhec/Misys multi-style/multi-class research program.
http://www.GloriaMundi.org/picsresources/rb-afm.pdf
- Amenc, N., and Martellini L., 2002a, "The Brave New World of Hedge Fund Indexes", Working Paper, Edhec/Misys multi-style/multi-class research program.
http://www.GloriaMundi.org/picsresources/rb-am2002a.pdf
- Amenc, N., Martellini, L., 2002b, "Portfolio Optimization and Hedge Fund Style Allocation Decisions", Journal of Alternative Investments, 5(2), 7–20.
- Amenc, N., Martellini, L. and Vaissié M., 2003, "Benefits and Risks of Alternative Investment Strategies", Journal of Asset Management, 4(2), 96-118.
- Amin, G. and Kat, H., 2003a, "Hedge Fund Performance 1990 – 2000: Do the Money Machines Really add Value?", Journal of Financial and Quantitative Analysis, 38(2), 251-274.
- Amin, G., Kat H., 2003b, "Stocks, Bonds and Hedge Funds", Journal of Portfolio Management, 29(4), 113-120.
- Asness, C., Krail, R. and Liew J., 2000, "Do Hedge Funds Hedge?", Journal of Portfolio Management, 28(1), 6-19.
- Brooks, C. and Kat H., 2002, "The Statistical Properties of Hedge Fund Returns and Their Implications for Investors", Journal of Alternative Investments, 5(2), 26-44.
- Brown, S.J., W.N. Goetzmann, and R.G. Ibbotson, 1999, "Offshore Hedge Funds: Survival and Performance 1989-95," Journal of Business 72(1), 91-117.
http://www.GloriaMundi.org/picsresources/rb-bgi.pdf
- Frank Russell Company, 2003, "Report on Alternative Investing by Tax-Exempt Organizations", (November).
http://www.GloriaMundi.org/picsresources/rb-fr2003.pdf
- Fung W. and D. Hsieh,, 2000, "Performance Characteristics of Hedge Funds and Commodity Funds: Natural vs. Spurious Biases", Journal of Financial and Quantitative Analysis, 35(3), 291–307.
- Learned, M. and Lhabitant, F.S., 2002, "Diversification: How much is enough?", Journal of Alternative Investments, 5(3), 23-49.
- Lhabitant, F.S., 2001, "Assessing Market Risk for Hedge Funds and Hedge Funds Portfolios", Journal of Risk Finance, Spring, 1-17.
- Liang, B., 2001, "Hedge Funds: The Living and the Dead", Journal of Financial and Quantitative Analysis, 35, 309-326.
- Lo, A., 2001, "Risk Management for Hedge Funds: Introduction and Overview", Financial Analysts Journal, 57, 16-33.
- Malkiel, B., 1995, "Returns from Investing in Equity Mutual Funds 1971 to 1991", Journal of Finance, 50(2), 549–572.
- Okunev, J. and White D., 2002, "Smooth Returns and Hedge Fund Risk Factors", Working Paper.
http://www.GloriaMundi.org/picsresources/rb-ow.pdf
- Posthuma, N. and Van der Sluis, P. J., 2003, "A Reality Check on Hedge Fund Returns", Working Paper.
http://www.GloriaMundi.org/picsresources/rb-pv.pdf
- Sharpe, W., 1992, "Asset Allocation: Management Style and Performance Measurement", Journal of Portfolio Management, 18), 7-19.
- Singer, B., Staub, R. and Terhaar, K., 2002, "The Appropriate Policy Allocation for Alternative Investments", UBS Global Asset Management.
- Spurgin, R., "How to Game your Sharpe Ratio", 2001, Journal of Alternative Investments, 4(3), 38-46.
- Vaissié, M., 2004a, "Are Hedge Fund Indexes Created Equal? (Part 1)", Alternative Investment Quarterly, 1st Quarter (10), 27-33.
- Vaissié, M., 2004b, "Are Hedge Fund Indexes Created Equal (Part 2)?", Alternative Investment Quarterly, 2nd Quarter (11), 28-38.
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ERRATA AND OTHER MATERIAL
- Other research by Lionel Martellini:
SSRN website
- Other research by Noël Amenc:
SSRN website
- Related research:
- Géhin, W., and M. Vaissié, 2005, "Lighthouses or Tricks of Light?" Journal of Indexes, (10), 22-26. (May/June).
Available online here with free registration.
- Goltz, F., L. Martellini and M. Vaissié, 2004, "Hedge Fund Indices from an Academic Perspective: Reconciling Investability and Representativity," working paper (November).
download (pdf 343K)
- Malkiel, B. and A Saha, 2004, "Hedge Funds: Risk and Return," working paper (December).
download (pdf 1380K)
- Van, G. and Z. Song, 2004, "Malkiel-Saha Hedge Fund Paper Flawed," working paper (December).
download (pdf 199K)
- Hedge fund indexes:
HFR database and indices:
http://www.hedgefundresearch.com
CSFB/Tremont Hedge Fund Indices:
http://www.hedgeindex.com
EACM 100 Index:
http://www.eacm.com/EACM100Index_Intro.htm
Dow Jown Hedge Fund Strategy Benchmarks Calculation Methodology
download (pdf 741K)
Standard & Poor's Hedge Fund Index: Structure Methodology Definitions Practices
download (pdf 1293K)
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