Sun, Mar 26, 2017
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Opalesque Futures Intelligence

Futures Lab: A study by Andrew Lo and Amir Khandani showed a surprising result for managed futures returns.

Thursday, February 24, 2011


Andrew Lo

Liquidity and a Premium?
By Chidem Kurdas


This is a brief review of a surprising result from a working paper by Andrew Lo and Amir Khandani. Professor Lo is both a practitioner of managed futures and a professor of finance at MIT as well as director of MIT's Laboratory for Financial Engineering. He is the author of numerous academic papers and books, including Hedge Funds: An Analytic Perspective.
In 1999 he founded AlphaSimplex Group, now a subsidiary of Natixis Global Asset Management. He is co-portfolio manager of ASG Managed Futures Strategy Fund, a trend-following mutual fund launched in 2010, and of ASG Global Alternatives, a mutual fund that trades futures and forwards to obtain a similar return to a diversified portfolio of hedge funds.
The paper we draw on is titled "Illiquidity Premia in Asset Returns: An Empirical Analysis of Hedge Funds, Mutual Funds, And US Equity Portfolios". This highly technical article may not be everybody's cup of tea, but the findings include an intriguing result regarding returns from managed futures-namely that they carry a premium associated with illiquidity in other types of investment.

It should be noted that the study as a whole is not about managed futures and the particular finding reported here happened to show up in an analysis of liquidity-we are focusing on only a small part of the overall research.


Managed futures is one of the most liquid investments. One way of measuring this is by comparing redemption notice periods, shown for selected hedge fund sectors in the table below. The average withdrawal notice for managed futures is orders of magnitude shorter than that for all other strategies.
-------------------------------------------------------------------------------------------------------------------------------------------

Hedge Funds' Redemption Notice Periods (averages, in days)

Event-driven

50

Fund of funds

40

Convertible arbitrage

37

Fixed Income Arbitrage

34

Long/short equity hedge

31

Emerging Markets

27

Global Macro

20

Managed futures

8

SOURCE: "Illiquidity Premia in Asset Returns: An Empirical Analysis of Hedge Funds, Mutual Funds, And US Equity Portfolios" working paper by Lo and Khandani.
----------------------------------------------------------------------------------------------------------------------------------------------

Professor Lo has investigated this topic for some time. In previous studies he and others showed that autocorrelation (or serial correlation) is an indicator of the degree of liquidity-see references. Serial correlation means returns are predictable from earlier returns, a pattern not expected in an efficient market but explained by the presence of illiquidity.

Illiquid investments like private equity are typically autocorrelated. By contrast, managed futures returns have no significant autocorrelation-in other words, they're not predictable, an indication of high liquidity.

Illiquidity, like other risks, requires compensation. As expected, illiquid strategies have large risk premiums. For instance, Lo & Khandani estimate that convertible arbitrage has a risk premium of 9.9%.

Managed futures, being highly liquid, should not have any illiquidity premium. Surprisingly, Lo & Khandani find that managed futures returns do contain a premium of 4.9%. They suggest there is significant variability in liquidity among managed futures funds. But the study does not focus on explaining this finding.

Whether managed futures still earns a risk premium is unclear. Lo & Khandani's hedge fund data is for the 30-year period from 1986 to 2006. It is possible that this result does not extend beyond that period. But it is intriguing that there is an illiquidity premium built into the returns from a very liquid investment. It sounds like having your cake and eating it, too.

REFERENCES
Lo, A., 2001. "Risk Management For Hedge Funds: Introduction and Overview", Financial Analysts Journal, 57, 16-33.

Getmansky, M., Lo, A., and I. Makarov. 2004. "An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns", Journal of Financial Economics, 74, 529-609.



 
This article was published in Opalesque Futures Intelligence.
Opalesque Futures Intelligence
Opalesque Futures Intelligence
Opalesque Futures Intelligence
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Hedge fund liquidations in 2016 surpass 2009 levels, new launches decline[more]

    Benedicte Gravrand, Opalesque Geneva: Even as the hedge fund industry's total assets exceeded the $3tln milestone last year, hedge fund liquidations increased. So much so that 2016 had the highest number of liquidations since 2008, claims the latest HFR Market Microstructure Report, re

  2. Hedge funds find no joy in macro as returns lag Trump rally[more]

    From Gulfnews.com: In 2017, macro hedge funds were expected to shine. So far? Not so much. It's been a far from impressive first two months for funds that trade around macroeconomic events. Discretionary funds rose just 0.3 per cent through February, according to Hedge Fund Research Inc., while the

  3. Strategies - Billionaire investor Marc Lasry shares how he's playing markets right now, Classic models are failing FX hedge funds desperate for return[more]

    Billionaire investor Marc Lasry shares how he's playing markets right now From CNBC.com: Buy on the prospect of deregulation. Sell on the enactment of deregulation. That's the strategy that billionaire investor Marc Lasry is implementing, according to an interview with CNBC in Las Vegas

  4. Opalesque Exclusive: Aberdeen makes the case for the lower mid-market[more]

    Bailey McCann, Opalesque New York: Aberdeen Asset Management has released a new paper focused on lower mid-market private equity. According to the paper, this segment of the private equity market is gaining popularity with private equity investors that are looking for multiple expansion and less

  5. Hedge funds await outcome of French elections, feel pinch on lower oil prices & weak dollar[more]

    Komfie Manalo, Opalesque Asia: Hedge funds felt the pinch of lower oil prices and weak U.S. dollar as the Lyxor Hedge Fund Index was marginally down as of the week ending 14 March, Lyxor Asset Management said in its Weekly Briefing. The Lyxor He