Tue, Jan 24, 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. Investing - This hedge fund made 37% betting on banks in 2016 and remains bullish after the Trump rally, Hedge fund legend David Einhorn is making a big bet on GM, After impressive 85% return in 2016, hedge fund looks to Canadian gold producer, small banks[more]

    This hedge fund made 37% betting on banks in 2016 and remains bullish after the Trump rally From Forbes.com: Can bank stocks continue to rise after a 28% surge in the KBW Bank Index in 2016, fueled by a post-election rally as stock pickers returned to the beaten down sector? Forget the s

  2. SWFs - China sovereign wealth fund CIC plans more U.S. investments[more]

    From Reuters.com: China Investment Corporation (CIC), the country's sovereign wealth fund, is looking to raise alternative investments in the United States due to low returns in public markets, its chairman said on Monday. CIC will boost its investments in private equity and hedge funds as wel

  3. Some hedge funds strong start in 2017 nice contrast to 2016[more]

    With the 2016 HSBC Hedge Weekly performance rankings in the books - a year in which the same leader-board entries pretty much dominated unchallenged throughout the year - comes a new leader board that is a hard-scrabble mix of hedge fund styles and categories. What is clear after but a few short wee

  4. Macro hedge funds and CTAs outperform in December on strong dollar[more]

    Komfie Manalo, Opalesque Asia: The last month of 2016 saw risk assets climbing higher, as part of expectations that the new U.S. administration will remove barriers to growth and investment, Lyxor Asset Management said. December also saw the Fed hik

  5. Opalesque Exclusive: Roxbury credit events UCITS gathers more assets[more]

    Benedicte Gravrand, Opalesque Geneva for New Managers: The Roxbury Credit Events Fund, launched in September 2015, was up 4.24% in 2016, having returned seven positive months during the year. The managers raised