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Alternative Beta Strategies and Hedge Fund Replication

Book Description

There s a buzzword that has quickly captured the imagination of product providers and investors alike: "hedge fund replication". In the broadest sense, replicating hedge fund strategies means replicating their return sources and corresponding risk exposures. However, there still lacks a coherent picture on what hedge fund replication means in practice, what its premises are, how to distinguish di erent approaches, and where this can lead us to.

Serving as a handbook for replicating the returns of hedge funds at considerably lower cost, Alternative Beta Strategies and Hedge Fund Replication provides a unique focus on replication, explaining along the way the return sources of hedge funds, and their systematic risks, that make replication possible. It explains the background to the new discussion on hedge fund replication and how to derive the returns of many hedge fund strategies at much lower cost, it differentiates the various underlying approaches and explains how hedge fund replication can improve your own investment process into hedge funds.

Written by the well known Hedge Fund expert and author Lars Jaeger, the book is divided into three sections: Hedge Fund Background, Return Sources, and Replication Techniques. Section one provides a short course in what hedge funds actually are and how they operate, arming the reader with the background knowledge required for the rest of the book. Section two illuminates the sources from which hedge funds derive their returns and shows that the majority of hedge fund returns derive from systematic risk exposure rather than manager "Alpha". Section three presents various approaches to replicating hedge fund returns by presenting the first and second generation of hedge fund replication products, points out the pitfalls and strengths of the various approaches and illustrates the mathematical concepts that underlie them.

With hedge fund replication going mainstream, this book provides clear guidance on the topic to maximise returns.

Table of Contents

  1. Cover Page
  2. Title Page
  3. Copyright
  4. Dedication
  5. Contents
  6. Preface
  7. Chapter 1: Breaking the Black Box
    1. 1.1 NEW POPULARITY, OLD CONFUSION
    2. 1.2 THE CHALLENGES OF UNDERSTANDING HEDGE FUNDS
    3. 1.3 LEAVING ALPHAVILLE
    4. 1.4 THE BEAUTY OF BETA
    5. 1.5 ALTERNATIVE VERSUS TRADITIONAL BETA
    6. 1.6 THE REPLICATION REVOLUTION
    7. 1.7 FULL DISCLOSURE
  8. Chapter 2: What Are Hedge Funds, Where Did They Come From, and Where Are They Going?
    1. 2.1 CHARACTERISTICS OF HEDGE FUNDS
    2. 2.2 HEDGE FUNDS AS AN ASSET CLASS
    3. 2.3 TAXONOMY OF HEDGE FUNDS
    4. 2.4 MYTHS, MISPERCEPTIONS, AND REALITIES ABOUT HEDGE FUNDS
    5. 2.5 A SHORT HISTORY OF HEDGE FUNDS
    6. 2.6 THE HEDGE FUND INDUSTRY TODAY
    7. 2.7 THE FUTURE OF HEDGE FUNDS – OPPORTUNITIES AND CHALLENGES
  9. Chapter 3: The Individual Hedge Fund Strategies' Characteristics
    1. 3.1 EQUITY HEDGED – LONG/SHORT EQUITY
    2. 3.2 EQUITY HEDGED – EQUITY MARKET NEUTRAL
    3. 3.3 EQUITY HEDGED – SHORT SELLING
    4. 3.4 RELATIVE VALUE – GENERAL 16
    5. 3.5 RELATIVE VALUE – FIXED INCOME ARBITRAGE
    6. 3.6 RELATIVE VALUE – CONVERTIBLE ARBITRAGE
    7. 3.7 RELATIVE VALUE – VOLATILITY ARBITRAGE
    8. 3.8 RELATIVE VALUE – CAPITAL STRUCTURE ARBITRAGE
    9. 3.9 EVENT DRIVEN – GENERAL
    10. 3.10 EVENT DRIVEN – MERGER ARBITRAGE
    11. 3.11 EVENT DRIVEN – DISTRESSED SECURITIES
    12. 3.12 EVENT DRIVEN – REGULATION D
    13. 3.13 OPPORTUNISTIC – GLOBAL MACRO 38
    14. 3.14 MANAGED FUTURES
    15. 3.15 MANAGED FUTURES – SYSTEMATIC
    16. 3.16 MANAGED FUTURES – DISCRETIONARY
    17. 3.17 CONCLUSION OF THE CHAPTER
  10. Chapter 4: Empirical Return and Risk Properties of Hedge Funds
    1. 4.1 WHEN THE SHARPE RATIO IS NOT SHARP ENOUGH
    2. 4.2 CHALLENGES OF HEDGE FUND PERFORMANCE MEASUREMENT – THE ISSUE WITH HEDGE FUND INDICES
    3. 4.3 SOURCES OF EMPIRICAL DATA
    4. 4.4 RISK AND RETURN PROPERTIES OF HEDGE FUND STRATEGIES
    5. 4.5 COMPARISON WITH EQUITIES AND BONDS
    6. 4.6 DEVIATION FROM NORMAL DISTRIBUTION
    7. 4.7 UNCONDITIONAL CORRELATION PROPERTIES
    8. 4.8 CONDITIONAL RETURNS AND CORRELATIONS
    9. 4.9 HEDGE FUND BEHAVIOR IN EXTREME MARKET SITUATIONS
    10. 4.10 BENEFITS OF HEDGE FUNDS IN A TRADITIONAL PORTFOLIO
    11. 4.11 QUANTITATIVE PORTFOLIO OPTIMIZATION FOR HEDGE FUNDS REVISITED
    12. 4.12 SUMMARY OF EMPIRICAL PROPERTIES
    13. 4.13 APPENDIX: DATA PROVIDERS FOR PAST HEDGE FUND PERFORMANCE
  11. Chapter 5: The Drivers of Hedge Fund Returns
    1. 5.1 ALPHA VERSUS BETA
    2. 5.2 THE ENIGMA OF HEDGE FUND RETURNS
    3. 5.3 HEDGE FUND RETURNS: HOW MUCH IS ALPHA?
    4. 5.4 THE EFFICIENT MARKET HYPOTHESIS
    5. 5.5 QUESTIONING THE EFFICIENT MARKET HYPOTHESIS: BEHAVIORAL FINANCE
    6. 5.6 THE THEORETICAL FRAMEWORK OF MODERN FINANCE: ASSET PRICING MODELS AND THE INTERPRETATIONS OF ALPHA
    7. 5.7 SYSTEMATIC RISK PREMIA: THE PREVALENCE OF BETA IN THE GLOBAL CAPITAL MARKETS
    8. 5.8 RISK PREMIA AND ECONOMIC FUNCTIONS
    9. 5.9 MARKET INEFFICIENCIES: THE ‘SEARCH FOR ALPHA’
    10. 5.10 AN ILLUSTRATION OF THE NATURE OF HEDGE FUND RETURNS
    11. 5.11 THE DECREASE OF ALPHA
    12. 5.12 THE BEAUTY OF ALTERNATIVE BETA
    13. 5.13 THE FUTURE OF HEDGE FUND CAPACITY
    14. 5.14 MOMENTUM AND VALUE
    15. 5.15 ACTIVE STRATEGIES AND OPTION-LIKE RETURNS
    16. 5.16 WHY MANAGER SKILL MATTERS
    17. 5.17 BUYER BEWARE: SOME FINAL WORDS OF CAUTION ABOUT HEDGE FUND RETURNS
  12. Chapter 6: A First Approach to Hedge Fund Replication – Linear Factor Models and Time Series Replication Models
    1. 6.1 REVISITING SHARPE'S APPROACH
    2. 6.2 UNDERSTANDING LINEAR FACTOR ANALYSIS: CRITERIA FOR THE FACTOR MODEL APPROACH
    3. 6.3 THE MODEL SPECIFICATION PROBLEM
    4. 6.4 THE DATA QUALITY PROBLEM
    5. 6.5 THE DEVELOPMENT OF HEDGE FUND FACTOR MODELS
    6. 6.6 BASIC AND ADVANCED FACTOR MODELS FOR HEDGE FUND STRATEGIES
    7. 6.7 HOW GOOD ARE OUR MODELS?
    8. 6.8 VARIABILITY OF RISK EXPOSURES AND PERSISTENCE OF FACTOR LOADINGS
    9. 6.9 CAN WE CREATE HEDGE FUND REPLICATIONS WITH LINEAR FACTOR MODELS?
    10. 6.10 THE LIMITATIONS OF LINEAR FACTOR MODELS
    11. 6.11 CURRENTLY AVAILABLE HEDGE FUND REPLICATION PRODUCTS BASED ON RFS
    12. 6.12 SUMMARY AND CONCLUSION OF THE CHAPTER
  13. Chapter 7: The Distributional Approach
    1. 7.1 BEING LESS AMBITIOUS
    2. 7.2 GENERAL PRINCIPLES OF THE DISTRIBUTIONAL APPROACH
    3. 7.3 INTEGRATION OF CORRELATIONS AND DEPENDENCIES
    4. 7.4 LIMITATIONS OF THE REPLICATION APPROACH
    5. 7.5 THE EMPIRICAL RESULTS OF THE DISTRIBUTIONAL METHOD
    6. 7.6 CONCLUSION FOR THE DISTRIBUTIONAL APPROACH
  14. Chapter 8: Bottom up: Extraction of Alternative Beta and ‘Alternative Beta Strategies’
    1. 8.1 THE RULE-BASED ALTERNATIVE
    2. 8.2 WHAT HEDGE FUND INVESTORS REALLY WANT
    3. 8.3 THE FIRST ‘ALTERNATIVE BETA’ STRATEGIES
    4. 8.4 RELATING HEDGE FUND RETURNS AND RISK PREMIA: WHAT WE CAN MODEL
    5. 8.5 ALTERNATIVE BETA STRATEGIES FOR INDIVIDUAL HEDGE FUND STYLES AND STRATEGY SECTORS
    6. 8.6 NEW EXOTIC BETA
    7. 8.7 THE QUESTION OF ASSET ALLOCATION
    8. 8.8 THE LIMITATIONS OF HEDGE FUND REPLICATION
    9. 8.9 A NOTE ON THE ISSUE OF LIQUIDITY
    10. 8.10 SUMMARY
  15. Chapter 9: Hedge Fund Portfolio Management with Alternative Beta Strategies
    1. 9.1 THE TASKS OF THE HEDGE FUND PORTFOLIO MANAGER
    2. 9.2 THE LURE OF SAVING FEES
    3. 9.3 THE LIMITATIONS OF HEDGE FUND REPLICATION
    4. 9.4 THE ROLE OF ASSET ALLOCATION
    5. 9.5 SEPARATION OF TASKS FOR THE FUND OF FUNDS MANAGERS
    6. 9.6 THE IDEA OF A CORE–SATELLITE APPROACH TO HEDGE FUND INVESTING
    7. 9.7 ISOLATING PURE ALPHA
    8. 9.8 THE FIRST PART IN THE INVESTMENT PROCESS: ALLOCATION TO STRATEGY SECTORS
    9. 9.9 IMPLEMENTATION OF TACTICAL ASSET ALLOCATION IN A CORE–SATELLITE APPROACH TO HEDGE FUND PORTFOLIOS
    10. 9.10 THE SECOND ELEMENT: MANAGER SELECTION
    11. 9.11 ACTIVE POST-INVESTMENT RISK MANAGEMENT
    12. 9.12 SUMMARY AND CONCLUSION
  16. Chapter 10: Replication and the Future of Hedge Funds
    1. 10.1 BEYOND ALPHA
    2. 10.2 WHAT DO INVESTORS SAY SO FAR?
    3. 10.3 REPLICATION AND THE FOUR KEY CHALLENGES TO THE HEDGE FUND INDUSTRY
    4. 10.4 REPLICATION IN REALITY
    5. 10.5 REPLICATION AND HEDGE FUND GROWTH
    6. 10.6 HEDGE FUNDS IN THE BROADER CONTEXT: THE FUTURE OF ABSOLUTE RETURN INVESTMENT
  17. References and Bibliography
  18. Index