Research

Hedge Fund Alpha – Net Zero Using a Dynamic Factor Approach – Using a novel database, the NilssonHedge hedge fund database covering more than 350,000 return observations, we perform a large-scale multiple regression. We evaluate alpha against the Fama French five-factor model including momentum. Our findings are compatible with a net-zero alpha from hedge funds after fees, assuming frictionless factor implementation. On the positive side, our analysis reveals a substantial divergence between funds, leaving room for timing and selection opportunities within most of the strategies.

Rush For Duration – Fixed income indices are designed to include a large number of rebalancing-driven changes that are responsible for creating price pressure events, through inclusion and exclusion effects, and coupon reinvestment that occurs based on the index rules. These events are highly predictable and result in a source of alpha for unconstrained active managers capable of absorbing tracking-error risk.

The anomaly depends on issuance and the aversion against duration risk for passive managers. The primary drivers of these flows relate to bond issuance and coupon payments. As long as the issuance schedule is busy, and index managers are unwilling to take duration risks, these price pressures will continue to persist.

Did the New Fix, Fix the Fix? An Intraday Exploration of the Precious Metal Fixing – We study the impact and changes to the precious metal Fixing structure that took place in 2014 and 2015 for Gold, Silver, Palladium, and Platinum. We find that there is negative price pressure going into the auctions, for all precious metals, outside active US trading hours regardless of Fixing structure. For active US trading hours, there are no obvious, observable persistent price pressures.

We find no conclusive signs that the price is manipulated into the Fix given public price data. Nor do we find any significant change in the price and volume structure. Given the higher transparency and more Fix participants, we would have expected changes if the market structure truly changed. Rather, we observe similar activities around settlement times.

Continuous Risk Adjustment – Does the Half-Life Have Implications for the Return Distribution – Risk Parity, Quantitative Trading Strategies, and Volatility Managed portfolios scales positions inversely to estimates of volatility. We study the impact of continuous risk adjustment for a set of Futures markets.

The shorter the half-life of a risk adjustment strategy is, the more normal our returns look like using a standard test for normality. Returns are still non-normally distributed, but for financial markets, a continuous risk-adjustment process manages to create a more well-behaved distribution.
The result has an important impact on so-called risk-parity portfolios that are thus not automatically riskier due to various optimization techniques and leverage, at least in the absence of heterogeneous methods to estimate and manage risk.

Turn-of-the-Month: Window Dressing Behavior – We study the impact of trading during the end of the month cycle. We find that there is a meaningful negative expected return from owning equities in the last trading hour of the month. The effect is large and potentially exploitable by investors that are not tied to monthly reporting cycles. The return pattern is different from other days in equity markets and has persisted over more than a decade. The effect is generally larger for US small-cap indices than large-cap indices.

The reasons for the effect may be related to window dressing by fund managers, risk control, lottery-ticket behavior, or less likely market manipulation. The effect applies to broad indices making it less likely that it is driven by a few traders but rather by the behavior of a large group of traders responding to the same incentives.

The Curious Case of the Pre-FOMC Drift – The pre-FOMC drift was first published in 2011 and is a strong driver of equity market performance over the last 30 years. The effect is able to explain approximately half of all the equity market returns over the measured period. We verify the results of prior studies. Furthermore, the report dives into conditional factors; equity market trend, and monetary policy action to see if there is any difference in terms of macro variables.

We find that FOMC is rather stable throughout time, macro conditions and has not been dependent on a particular Fed Chair. It seems as if the markets are expecting that the FOCM will infuse optimism into equity markets as the majority of the gains occurs before the actual announcement. The effect can be due to behavioral issues and herding among market participants but can also be due to information leakage. The effect remains unexplained.

Trend Following – Expected Returns – We derive and calculate an ex-ante expectation for generalized trend-following rules, both on a single market as well as for a portfolio of trend strategies. Furthermore, the efficiency of trend-following rules applied to synthetic market data with varying degrees of drift and autocorrelation is discussed. Findings indicate that there is a positive relationship between drift, autocorrelation, and the theoretically extractable Sharpe ratio for a trend following strategy. Drift is more important since it is theoretically unbounded, but strong auto-correlation can create positive returns in the absence of long-term drift.

The expected Sharpe ratio of a trend strategy is proportional to the absolute drift and auto-correlation of a market above a threshold. The expected return of a portfolio of trend strategies is also sensitive to the average correlation between the individual trading systems. Anyone engaging in trend following strategies should expect to generate positive returns if the drift is strong enough or if there is enough autocorrelation, but should seldom expect to beat a market.