Comparing the different editions of the Axioma Quarterly Risk Review for 4th Quarter 2011 leaves some fascinating insights. For example, it is becoming more difficult over time, in much of the world, for investors to create significant diversification within the (domestic) equity portion of their portfolio, because the correlations of stock pairs have been increasing.

Because of the furor over ABACUS and analogous transactions, the legislative mandate of the Volcker rule came to include a section 619, telling the SEC to ban underwriters or sponsors of asset-backed securities from engaging “in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity.” On Monday, February 13, the final day for comment on the proposed rule, some of the more fascinating comments spoke to this issue.

The Global Association of Risk Professionals has surveyed risk managers, analysts and academics to get a sense of the implications of the demise of MF Global Holdings for the role of risk managers. Its findings add to a growing sense that the firm’s last chief executive, Jon Corzine, a former New Jersey Governor and U.S. Senator, was an edge-dwelling trader at heart, eager (as Dealbook put it in an analysis in December) to play a “hands-on role in the firm’s high-stakes risk-taking;” indeed, a man enmeshed in a “romance with risk.”

Data on the endowments of institutions of higher learning shows a significant spread between the performance of the largest endowments and the lagging performance of the smaller. The return that endowments received on their use of alternative strategies, too, depends in part upon the size of the endowment doing the investing. Endowments under $25 million in assets under management made only 9.5 percent on this asset class in FY 2011, while those with more than $1 billion in AUM made a 16.9 percent return hunting in the same jungles.

Infrastructure is a perpetual investment, whether it's rebuilding old, existing underpinnings in developed markets or building the foundations that turn an emerging nation into a developing one. Preqin looks at this lesser known investment that underpins many alternative portfolios.

Emerging OTC derivatives in the emerging markets of Latin America and Asia are just one more sign that these countries are growing up.

"Farhaz Miah, of Preqin, sets out the numbers for private real estate fundraising in 2011, showing that the market continues to suffer from the impact of the 2008 crisis. He notes, also, that debt strategies have become increasingly popular, both in specifically debt-strategy funds and in opportunistic funds that employ debt strategies as part of a broader structure."

AAA sat down with Alex Gurvich and Jim Mitchell, both of The Rockledge Group, an investment advisory firm headquartered in Brooklyn, New York. We began by discussing the mid-January launch of a new product that gives the long-short equity strategy an ETF format, and ended up talking about a good deal else, such as the inherent superiority of ETFs over mutual funds, and Pimco's recent recognition of that fact.

Since transaction costs and the illiquidity of certain portions of an index make ideal tracking impossible, there will be a difference between the return of a tracking ETF, such as those tracking ETFs that are structured as UCITS in Europe, and the return of the underlying index or benchmark. The European Securities and Markets Authority maintains that investors should be informed of the factors that are likely to affect the size and the volatility of this difference.

Alpha Hunter Khiem Do talks about Asia and where the alpha is from his perspective.

The Hartford (CT) CFA Society recently hosted a workshop on “Pension Risk Management and Governance.” The discussion proved to be mostly, though not exclusively, about ERISA and about how plan sponsors may arm themselves against the sorts of litigation it may inspire. Moderator Martin Rosenburgh, who is both an attorney and a financial analyst, and currently [...]

Two scholars affiliated with the Center for European Economic Research, drawing upon European data between 2000 and 2008, maintain that PE backed companies do not suffer from higher bankruptcy rates than their control group of comparable companies. Their paper also addresses the relationship between bankruptcy risk on the one hand and the syndicated (or, conversely, the stand-alone) nature of a PE deal. It finds no significant relationship.

The SEI asked institutional investors in hedge funds what was the number one reason for their inclusion of such funds in their portfolio. The most popular single choice was "absolute return." On the other hand, if you combine the numbers of the distinct answers that involve limiting the downside, then the percentage of respondents who gave some risk-management focused answer is 56 percent. As SEI says, this is "a marked cultural shift from the early days of hedge funds, when many investors focused on their potential to produce outsided returns."

In Singapore, some of the synthetic ETFs involve considerably more exposure to uncollateralized counterparty risk than the 10 percent or less that UCITS would allow. Singapore has, for example, the iShares MSCI India tracker, which has a 20 to 25 percent exposure. But Celent sees a possibiliuty that laxity will prove a winning move vis-a-vis Hong Kong.

AIMA, in a report sharply critical of the proposed European Union financial transaction tax, sets out the way in which the tax could burden businesses, and their consumers, to a degree far greater than the proponents contend. After all, any single product may pass through several stages between raw materials and final consumer, as there are several steps between farmer harvesting wheat and retail outlet, such as Tesco, selling pasta. Businesses at every stop along the way (farmers, wheat processers, pasta extruders) will naturally want to hedge their own operational risks in the financial markets, so the price of the finished product will reflect the repeated imposition of the FTT.

First, an investor (according to a new white paper on due diligence from Merlin Securities) must decide what kind of strategy it is to which he wants exposure, and generate a list of managers who practice that strategy. Thereafter he can focus on each firm on that list looking at each of the three (qualitative) components of management, and subjecting his impressions to a variety of (quantitative) tests. Tripartite divisions seem to come into play a lot.

It seems that Patrick Byrne is interested in using a lawsuit filed in Canada in October 2011 as an opportunity for contesting the substantive merits, that is, providing evidence that the conspiracy exists as described and that Nazerali’s part in it was accurately portrayed in the various webpages of Deep Capture (called “chapters” for some reason). That may well prove healthy.

Godfrey Cadogan's formula, linking high-frequency trading, bubbles and crashes all into one formula of extreme simplicity (or "parsimony" as Cadogan puts it) leaves our reporter wondering: does the rendering of facts as a formula make them clearer, or does it just create a misleading patina of precision? Emanuel Derman recently warned of the overly simple models of finance economists, and perhaps this is a new token of that type.

A recent study, in which Steve Kaplan of the University of Chicago collaborated with Bob Harris of the University of Virginia and Tim Jenkinson of Oxford, addressed fund-level performance using data from Burgiss Group. Kaplan said this study indicates that “private equity has performed remarkably well.” In the period 1990 to 2008, a dollar in PE returned to investors 300 to 400 basis points a year more than a dollar in the equities of the S&P 500, net of all fees. This, if accepted, still leaves the question of the relationship of PE funds/firms to one another. Are they all the same?

IMF economist Manmohan Singh, in a recent working paper for the IMF, makes a case that pledged collateral is a critical financial lubricant, and that since the collapse of Lehman in September 2008 there has been a significant and troubling decline in its supply. Certain measures intended by regulators to enhance financial stability may in fact undermine it, by worsening the supply/demand mismatch, in effect creating a grey market for this pledged collateral.

Celent says that both the IT world and the financial markets long assumed that the latter had to employ the former in a “batch mode.” A firm would process trades through the day, recording these in a data base. Then at the end of the day, programs that could manipulate this data in search of exploitable patterns would operate on the day’s results as a batch. That is the mode of operation that “has become increasingly obsolete.”

The Mathema report is full of cautions, and indeed adopts a quite generally gloomy tone. The markets, it tells us, don’t lend any credence to the political fixes that have been offered for the eurozone and especially for its peripheral players. If the fixes did have credibility, then the PIIGS’ 10-year government benchmark yields would have been falling significantly of late vis-à-vis the 10 year German Bund yield. But there has been no such fall.

If the actual results of the Korea Composite Stock Price Institute fitted a normal distribution (a "Bell curve,") then the index would record a daily loss larger than 3 percent only once every 1,219 years. In fact, it records such a loss once every 2.3 years. To fit the extraordinary real-world volatility of KOSPI and many other Asian markets, institutional investors especially should consider structured equity products that explicitly target a level of volatility.

At present, 21 percent of the world’s wealth belongs in the developed economies, but by 2020 that figure will have risen to 30 percent, according to a new report.

Distressed debt strategies have long been bedeviled by the shifting and thus unpredictable nature of the law of avoidance, or fraudulent conveyance, in the U.S. Perhaps it is, as some have said, because the law was written for a simpler time, and an industrial rather than a post-industrial country.

On Oct. 30, a Sunday, the Commodity Futures Trading Commission received a draft report from MF Global that for the first time showed a shortfall in the segregated funds, a deficit of $900 million. At this time, both MF Global and the CFTC were referring to this in anodyne terms as an “accounting error.”

Bandon Capital's managing directors believe it is possible to generate alpha from unique non-market sources, and that they do so through their forecasts of domestic and overseas sovereign interest rates.

A recent meeting of an advisory group of the CFTC discussed the proper definition for high frequency trading, on the premise that only once a definition is in place can there be focused monitoring of the consequences of HFT.

The European Debt crisis has been the epicenter of the most recent market earthquakes. Now that a resolution is on the table, the "What now?" question remains.

The Commodity Customer Coalition has now issued a white paper presenting its own view of the “background, impacts, and solutions to MF Global’s Demise.”

We near the third anniversary of the day (December 10, 2008) when the two sons of Bernard Lawrence Madoff informed authorities that their father had just admitted to them that his asset management operation was “one big lie.” One of those sons, Mark Madoff, killed himself one year and one day later. The dimensions of [...]

EisnerAmper LLP's latest edition of “Pulse of Private Equity” finds that PE firms in the second half of 2011 are becoming “more sober about the potential for transactions,” compared to last year or earlier this year.

Pragma studied the empirical relationship between the routing behavior of market participants and the fee structures of the venues through using publicly available trade and quantity (TAQ) data from June 2011....The hypothesis left standing is that the inverted fee structure acts as intended. "[W]hen there is a choice of where to take liquidity, the pecking order is clear and coincides with cost."

A new study from SEI shows If an alternative strategy can be offered in a mutual fund structure it has a much broader market opportunity than if not. Hedge fund managers want the mutual fund market just as mutual fund managers want to use the broader hedge fund range of strategies.

Could it be that truth is finally stranger than science fiction? The next battle of the quantitative trading strategies may offer some algorithmic features that look downright qualitative.

Amongst equity long-short funds, which constitute about half of the Asian hedge fund universe, the returns of hedge funds “were sometimes mean reverting but at other times displayed persistence in positive/negative momentum.” That is to say that sometimes a coin that has come up heads three times will come up tails the fourth time, but at other times it will persist in coming up heads the fourth time.

The hedge fund industry that invests in Asia is increasingly run from within the region, especially from the two hub cities of Hong Kong and Singapore, according to an August 2011 report by Singapore based consult In the early days of the Asian hedge fund industry, Asian strategies were quite generally run from outside of Asia [...]

The world is a fairly small pond in which ripples anywhere soon shake the surface everywhere. Such an observation, like the word “globalization,” has become a cliché, but the truth behind them both becomes quite obvious in the course of a new “Viewpoint” paper by Ernst & Young that examines fund distribution strategies in the [...]

Intuition (codified by many models) suggests that investors have to be bribed to accept risk, so that there ought to be a positive link for any given class of security between the amount of risk, and thus the measurement of volatility, on the one hand, and expected return on the other. A puzzle arises, then, from empirical research indicating that “idiosyncratic” volatility, that is, the volatility due to the characteristics of a specific security, is negatively correlated with return once one passes the mid-point of the range of volatility.

Spread capture is a percentage of the bid-ask spread, so that if an algorithm always accepts the outstanding offer when buying – if it is always the one to cross -- it will capture 0 percent of the spread. If a deal is concluded on its own bid determined through limit orders, on the other hand, it captures 100 percent of the spread. The spread capture metric is popular, the Pragma paper says, because it “reflects a widespread assumption that the higher the number the better the performance of the algorithm.”

Managers were asked: “other than delivering expected performance, what is the greatest challenge in satisfying investors?” The results were: getting investors comfortable with infrastructure, 22 percent; providing satisfactory performance attribution data, 19 percent; providing broader education/consulting, 18 percent; providing satisfactory risk analytics, 11 percent; other, 28 percent. The residual answer produced more favorable replies, then, than did any of the pre-scripted answers.

The classical philosopher Aristotle is often associated with the logical principle that every well-formed proposition is either true or false, either A or not-A.  Actually, Aristotle’s views were a bit more complicated than that. He raised the possibility for example that the truth of the statement “there will be a sea battle tomorrow” might be [...]

By Christopher Faille The ideas of “cause and effect” seem simple enough when left unexamined. The cue stick hits the cue ball; the cue ball hits the eight ball; the eight ball rolls into the pocket. How can anyone fail to understand this?

There is an old story often attributed to economist Burton Malkiel. A professor of finance and an undergraduate are walking together. They see what looks like a $100 bill lying on the sidewalk. The naïve student bends down to pick it up, but the professor says, “Don’t bother. If it were a real bill, it [...]

Cyril Demaria, a partner at Tiaré Investment Management in Zurich, and a former portfolio manager at Maaf Gestion, has written a book, Introduction to Private Equity, John Wiley & Sons Inc., Hoboken, N.J., 2010, 244 pp., $49.95. The subject matter is named well enough in the title. I’ll only add that Demaria uses the term “private [...]

By Christopher Faille Charles Jones of Columbia Business School made a presentation at an SIFR event in Stockholm, titled “What do we know about algorithmic and high-frequency trading?” Although a distinguished professor like Jones would not put the matter this way, his thoughts do have me thinking of the old human-inhabited trading floors, and their cyberspace [...]

The explosion of the subprime market may yet produce a significant change in the way investors and their managers with a distressed-assets strategy maneuver for advantage in the context of Chapter 11 proceedings

By Christopher Faille One of the great clichés used by reporters, commenters, bloggers and twitterers in recent months has been that the central bankers of the developed world, and/or their Treasuries, have “run out of bullets.” They have “spent all their ammunition” seeking stimulus already and will have nothing in reserve should there be another serious [...]

Alpha Hunters Andrew Timpson and Joseph Schlater of Busara Advisors talk about what it takes to get an emerging manager allocation.