When it comes to style drift in hedge funds, there is a lot of confusion as to what the term actually means. Investors and traders need to understand how this can affect their investments. In order to help you better protect yourself, we will be providing some useful information on this topic We'll go over some key points about style drift that should give you a good grasp on this subject matter and get you ready for the rest of the blog post! What is Style DriftWhen discussing style drift in hedge funds a good place to start is by defining the term itself. Style drift occurs when an investment portfolio's allocation is modified over time. Style drift may result in a portfolio's assets becoming more or less aggressive than it was designed to be, violating the expectations of investors. Style drift can occur naturally in a portfolio due to gains from certain assets and losses on others. A fund can also change if the investment manager changes or abandons the portfolio’s strategy. Usually, a portfolio manager's commitment to managing a fund's assets according to its stated investment style over several years is a key point of differentiation between funds. Historically, even the most actively managed hedge funds and other investment strategies have been able to withstand some style drift without affecting long-term performance. However, research has shown that extreme cases of style drift do affect fund returns and risk measures, especially over several years, as well as investor withdrawals from the fund. What are Hedge FundsHedge funds typically make more money with less risk, thanks to a portfolio of investments that uses different types of investment methods and assets. Hedge funds are not regulated by the SEC, so they are usually only available for accredited investors who qualify. Hedge funds are also offshore to some extent since they don't have to comply with SEC regulations. One aspect of hedge funds that has set them apart is the fact that they face less regulation than other investment tools like mutual funds. What is Style Drift in Hedge FundsStyle drift is a phenomenon in which hedge fund strategies change over time due to changes in the economy, asset prices, and market trends. The effects of style drift can have a significant impact on performance and risk measures for an investment portfolio. Style drift is one of the major issues for Hedge managers. Style drift typically begins small and evolves into more complex changes. Some managers may be able to avoid style drift by investing broadly and observing position limits. They can change their strategies and investment instrument to tune into the trends of changes in the market. Does Style Drift Affect PerformanceYES! Style drift can negatively affect performance if the manager loses control over their investment strategy due to any of the factors mentioned above. Hedge fund investors need to understand the strategies of their managers and the purpose their funds serve to maintain a healthy relationship. Does Style Drift Affect RisksYES! Style drift affects risks due to several factors that are listed below: Inappropriate asset allocation: If a portfolio's assets don't match its stated allocation; this would affect the risk profile of the portfolio. The passing of time: Over a period of time as a result of a change in market conditions, assets become riskier. The performance and allocation are no longer at par with what is expected from the strategy. Over Concentration: If an investor holds too much in one asset; it can create unnecessary risk. Under Concentration: If an investor holds too little in one asset it can create a significant loss due to lack of diversification. ConclusionAs you can tell by now, style drift can have an impact on a portfolio's risk, returns, and volatility. Therefore, it is vital to understand the investment style of your portfolio manager throughout the period of time you're invested in the fund. The effects of style drift are amplified by severe and drastic changes over a long period. However, changes that are gradual and less drastic can have a more limited effect on the portfolio's returns. The bottom line is that style drift affects risk by creating problems with asset allocation, the timing of trades, concentration levels in a fund. Originally Published Here: Style Drift in Hedge Funds
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Economics is a field of study that relates to analyzing various factors that affect a country's economy. These factors include production, distribution, and consumption of goods and services, collectively termed as value. However, the field of economics usually involves theoretical analysis. When it comes to quantifying these theories, there are several options. These include econometrics and mathematical economics. What is Econometrics?Econometrics is a field within economics that deals with applying statistical and mathematical models to analyze economic theories. This field relates to how analysts can test or prove various economic hypotheses through quantification. Analysts that use econometrics to do so are known as econometricians. The primary objective of econometrics is to use statistical and mathematical methods to develop theories or test existing ones. Econometrics is substantially helpful for analysts that use economic theories for trend analysis or forecasting. During the process, they use tools, such as regression analysis, time series analysis, probability, correlation analysis, etc. Depending on their needs, analysts can use these tools to make predictions and forecast future trends. Although econometrics involves using mathematical and statistical methods, it still relies on theory. The field exists since the 1970s. However, it has grown over the last 30 years. Most nations depend on econometrics to develop their economic policies and test those policies to assess their impact. What is Mathematical Economics?Mathematical economics is a field within economics the involves the use of mathematical principles to develop economic theories. Unlike econometrics, it does not include statistical analysis. Therefore, mathematical economics is more limited when it comes to its application. However, it does not imply that one field is more superior to the other. Through the use of mathematics, economists can develop accurately defined models using mathematical logic. Based on those models, they can reach conclusions, which they can use statistical models to test. Therefore, mathematical economics can contribute to the data required for analysts to apply in econometrics. Based on these models, analysts can also use statistical tools to make quantifiable predictions about economic activity. Mathematic economics plays a critical role in allowing economists to develop economic models. It can be significantly helpful when weighing various economic policies against each other and assessing their impact. Overall, mathematical economics helps economists describe an observable phenomenon. By doing so, it allows economists to develop a theoretical interpretation. What is the difference: Econometrics vs Mathematical Economics?Econometrics and mathematical economics involve similar areas. Econometrics usually deals with the application of both statistical and mathematical methods to the field of economics. It relates to how economists use these methods to develop or test economic models. It also involves using any interpreted data to make predictions or analyze trends. Mathematical economics, on the other hand, has limited application. However, it provides the basis for the use of econometrics. Mathematical economics deals with analyzing data using mathematical methods or models. By doing so, it provides the information necessary for economists to use in statistical models and econometrics. ConclusionEconometrics and mathematical economics are fields within economics that involve the quantification of economic theories. However, they are both different. Econometrics deals with the use of statistical and mathematical tools to analyze trends and predict future outcomes. Mathematical economics involves the application of mathematical models in the analysis of economic concepts. Post Source Here: Econometrics vs Mathematical Economics Holding-based style analysis is a type of investment strategy that can help you make better decisions about stocks. It takes into account the holding period and market capitalization to analyze a stock's risk, return, and volatility. The idea is to see if a particular company has an edge over its competitors because it possesses some unique quality or characteristic that cannot be easily duplicated by other companies in the same industry. Definition of Holding-based Style AnalysisHolding-based style analysis is a type of investment strategy used to describe the structure of a company's investment portfolio. It combines two different approaches to investing: valuation analysis (looking at a company's stock price in relation to its earnings and book value) and style analysis. Holding-based style analysis is used by investors, analysts, and traders to analyze the unique investment approach that an individual company has. Using this strategy allows you to determine whether or not a company's strategy is successful. It also helps you decide if the company is run by a good management team that has the ability to invest in and manage industry trends effectively. How does Holding-based Style Analysis workHolding-based style analysis is based on the premise that a company's performance can be analyzed through an examination of its investment portfolio. The portfolio gives you insight into how management manages the company's particular business trends. For example, if you are looking at a technology firm and you notice that it has increased its holdings in other technology stocks, such as software, you can assume that the company is reacting to technological trends in its business. A holding-based approach looks at a company's holdings and compares them to similar companies within the same industry. It then assesses the risk, returns, and volatility of each company in order to make an overall judgment about the way that management is investing the company's assets. Benefits of Holding-based Style AnalysisUsing this type of analysis to determine a company's investment strategy can help you make better buying decisions. You are able to more accurately assess the risks and returns associated with an investment in a particular stock. The holding-based approach has become much more relevant as institutional investors have shifted their focus away from stocks and bonds, and towards other types of assets such as derivatives and commodities. The holding-based style analysis strategy can also help you diversify your portfolio. If you are looking for a way to make your stock holdings more diverse, this investment approach may be right for you. The benefits of the Returns-based Style Analysis include
ConclusionHolding-based style analysis helps you decide if a particular company is a good investment or not. You are also able to see what type of management team is running the business and whether they have the ability to effectively manage industry trends. This may be especially important for small businesses and start-ups that do not necessarily have the capital or resources to invest in industry research and development. Post Source Here: Holding-based Style Analysis Return-based style analysis is a statistical technique that helps investors understand the risk and return characteristics of their portfolios. It does this by looking at how often different stocks in your portfolio go up or down, irrespective of what other stocks are doing. The idea behind return-based style analysis is to determine if you have any "overweight" positions in one sector with unusually high volatility, which could cause you to experience heavy losses when things don't go as planned for that particular industry. What is Return-based Style AnalysisReturn-based style analysis is a well-established and highly useful analytical tool. It attempts to determine an individual security's exposure to various market factors by examining how often the security has gone up or down over a specific period of time. The intent is to identify under-diversified holdings within your portfolio, so you can make adjustments if necessary. How does Return-based Style Analysis workThe Return-based Style Analysis is mostly used for the analysis of individual securities. The process involves determining an individual security's exposure to various market factors by examining how often the security has gone up or down over a specific period of time. Then, this information is used to evaluate the risk/return characteristics of your portfolio as a whole – and in particular, your sector exposure. The information generated by this procedure about the portfolio's sector exposure can then be compared to that of a benchmark index or some other theoretical market, such as a market of stocks that are weighted according to their projected earnings. Benefits of Return-based Style AnalysisReturn-based style analysis is a statistical technique that helps investors understand the risk and return characteristics of their portfolios. It does this by looking at how often different stocks in your portfolio go up or down, irrespective of what other stocks are doing. The idea behind return-based style analysis is to determine if you have any overweight positions (i.e. overweight positions in one sector with unusually high volatility, which could cause you to experience heavy losses when things don't go as planned for that particular industry) in your portfolio. The benefits of the Return-based Style Analysis include
ConclusionReturn-based style analysis is a well-established and highly useful analytical tool. It attempts to determine an individual security's exposure to various market factors by examining how often the security has gone up or down over a specific period of time. The intent is to identify under-diversified holdings within your portfolio, so you can make adjustments if necessary. The idea behind return-based style analysis is to determine if you have any overweight positions in one sector with unusually high volatility, which could cause you to experience heavy losses when things don't go as planned for that particular industry. Originally Published Here: Return-based Style Analysis A financial option is a rather complex instrument. Unlike delta-one products, an option value depends not only on the underlying, but also on volatility, time to maturity, strike, interest rate, and dividends. Options have been used as hedging instruments, but they’re becoming a speculative vehicle these days thanks to a growing number of retail traders and the increasing popularity of financial media. Even though options are derivatives, and thus trading them would require a different thinking, retail traders often apply delta-one trading techniques to options trading. One such popular technique is stop loss. The trading rule usually goes like this: sell options to collect premium, and if the marked-to-market loss exceeds a certain multiplier of the premium received, then exit. On this topic, Reference [1] examined the role of stop losses in options trading. Specifically, This paper is devoted to the research and development of profitable option sell-side trading strategies, and proposes an operating mechanism for stop-loss. In addition, statistical methods and random forest algorithms are used to estimate the win-rate of the strategy. The win-rate represents the proportion of all transactions that the premium has not doubled before settlement, and we can also express it with precision. After performing numerical experiments, the authors concluded, The experimental results can confirm that the trading strategy proposed by this paper can effectively achieve risk control through the development of a stop-loss mechanism with a fixed premium double multiple. And apply statistical methods and random forest algorithm to estimate the win-rate of the strategy, and screen out the trading range with higher profit and stable. The precision predicted by the model classification can prove that the strategy is practical and profitable. The paper led us to ask ourselves the following questions:
These are just some questions. Let us know what you think. Last and not least, we also observed from the paper:
References: [1] C-F Chao, Y-C Wang, M-E Wu, A Quantitative Model for Option Sell-Side Trading with Stop-Loss Mechanism by Using Random Forest, 2021, https://www.researchsquare.com/article/rs-769898/v1 Originally Published Here: Stop Losses in Options Trading This is not to be confused with the equal-weighted ETF which has created a lot of buzz in recent months. Equal-weighting commodities can be risky because you are investing in assets that may have been undervalued or overvalued for extended periods of time, but this method does have its benefits and should not be ignored altogether. In general, it's good to diversify your portfolio with both low-risk and high-risk investments so as not to lose all your money when one investment tanks. What is the Equal-Weighted Commodity IndexThe equal-weighted commodity index is a portfolio of futures contracts on commodities that are equally weighted. It takes the price of multiple commodities and calculates an average, then buys all those assets in proportion to their value, which can be done because the prices are quoted in dollars per unit so it's as easy as dividing by the quantities purchased. This is a way to diversify your assets across multiple sectors of the economy and give you access to an asset class that isn't readily available in typical portfolios. How is the Equal-Weighted Commodity Index CalculatedThe equal-weighted commodity index is calculated by taking the current price of each asset and dividing it by its average historical value, then multiplying that result by the quantity purchased. An example of how this is done can be seen below: (Brent Crude Oil Price / Average Historical Price) * Quantity Purchased = Weighted Average Price For example, if you have a current price of $100 and an average historical value of $80, then: (100/80) * 5 = $125 This means that for every dollar invested, you would receive four dollars' worth of oil. There is some inherent risk in this strategy because the high-risk commodities will make up a greater portion of the portfolio. So if gold and silver prices skyrocket, your portfolio will be heavily weighted in those assets which could become dangerous if they were to suddenly crash. However, this is not a bad strategy because you should have a diversified portfolio anyway. It gives you access to an asset class that would normally only be available to institutional investors, at least to a limited degree. How does the Equal-Weighted Commodity Index compare with other indexesIt has been shown that commodities tend to rise when equities are falling, and vice versa. However you should be cautious about investing in commodities because they are much more volatile than stocks, so there is a greater chance that you'll lose a lot of money in them if the prices plummet. In addition, investing in commodities is not as liquid or simple as trading stocks because most indexes are value-weighted and therefore only take into account the current price of each asset, not its average historical value. Advantages and Disadvantages of Equal-Weighted Commodity IndexThe Equal-weighted Commodity Index comes with both advantages and disadvantages. Advantages
Disadvantages
ConclusionInvesting in the Equal-weighted Commodity Index is a great way to gain exposure to an asset class that does not represent the market as a whole. However, because commodities tend to move together and have been extremely volatile in the past, this option will likely result in your portfolio declining if you invest too heavily into it. Article Source Here: Equal-Weighted Commodity Index A market capitalization-weighted index is an equity index that measures the performance of a selection of stocks from a particular region or market. The cap-weighted indexes are some of the most commonly used indices because they measure the relative size (or weight) of each company in the portfolio, and can be used to help assess both volatility and liquidity levels. In this blog post, we are going to look at what a market capitalization-weighted index is and how it actually works. What is a Market Capitalization-Weighted IndexA market capitalization-weighted index is an equity index that measures the performance of the equities in a particular region or market. Cap-weighted indexes are some of the most commonly used indices, as they measure size accurately and can be used to assess volatility and liquidity levels. The cap-weighted indexes are constructed so that an equal amount of money is invested in each stock. Each company's capitalization or 'market cap' is determined by multiplying the current market price of one share (usually expressed in USD) by the total number of shares outstanding for that company, with a minimum of $1 million and a maximum of $5 billion. For example, if there are two companies in a portfolio and both have market capitalizations of $2 billion each, then the weighting for company A will be 50% and company B will hold the remaining 50%. The weightings cannot add up to more than 100%, unlike with an equal-weighted index. How Does Market Capitalization-Weighted Index WorkWith an index, a portfolio is chosen and is weighted to reflect the market or regional economy. For example, in Australia, the top 50 companies listed on the stock exchange have been selected to make up the All Ordinaries Index - which has a weighting of 16% for each company that represents a fair reflection of the Australian economy. This method of calculating a portfolio's weight is known as capitalization-weighted. The calculation for the market cap is straightforward – it involves multiplying the price of a stock by the number of shares issued while setting a minimum value on total assets and adjusting for foreign exchange fluctuations to arrive at a figure. In the case of an index fund, all stocks are divided by the total market cap of all stocks in the index to arrive at a percentage. Why is Market Capitalization-Weighted Index ImportantThe market capitalization-weighted index has long been the most widely used method for constructing an index fund or a portfolio of securities. Market cap is calculated using each company's share price multiplied by the number of shares outstanding, with some exceptions including financial service companies (banks). Another reason why the market cap is important in constructing an index is that trading securities using this method will ensure that a portfolio represents the companies with the highest value and most liquid stocks. Liquidity refers to the ability of an investor to enter or exit a stock without moving its price substantially, which makes it easier for investors looking for a short-term buy-and-hold strategy. ConclusionThe market capitalization-weighted index is one of the most used indexes in finance. It's a weighted average where each share price has an equal weighting and represents the value of that company on the stock exchange. So you can get a better view of the market in general. Article Source Here: Market Capitalization Weighted Index For many of us, inflation has been a constant worry in recent years. One way to protect ourselves from the effects of inflation is by hedging our investments. So let's take a look at how can we hedge against inflation. What is Inflation?Inflation is a type of rising in prices across the board. If you have ever been on a shopping spree at the grocery store, you will probably agree that inflation has caused some of our groceries to become more expensive over time. The easiest way to think about it is as follows: Suppose you need 100 dollars today to buy certain goods and services. Inflation means that the next time you buy those same goods and services, you will need more than 100 dollars to do so. In simple words, inflation is a rise in prices over time, while deflation is a fall in prices. This also means that there is only one form of currency inflation and two forms of currency deflation. What Causes Inflation?Inflation happens when there's an increase in what's called "monetary supply". This includes everything from printing up money to issuing more debt. For example, when the U.S. government wants to boost economic growth they'll typically print a lot of money to pay their expenses. This increases the supply and reduces the purchasing power of everyone else's dollars. How Does Inflation Impact Your Portfolio?The two main ways that inflation impacts your portfolio are: on an absolute basis (i.e. it erodes the value of your portfolio) and on a relative basis (i.e. it increases your cost for trading). Let's take a look at both of these effects in detail below. Impact Of Inflation On An Absolute BasisMonetary inflation means that the purchasing power of our money will decline over time. If you think about it, it does actually make sense. If the Fed takes $100 and prints 10 more $10 bills, then we need to spend 100 dollars today in order to get what used to cost 80 dollars yesterday. Impact Of Inflation On A Relative BasisWhen inflation goes up, expenses go up as well. And when expenses go up, so do our trading costs. As the price of a stock goes up with inflation, the number of dollars we need to spend on that stock also increases with inflation. How to Hedge Against Inflation?There are many ways to hedge against inflation. Most of the time, people will use interest-bearing investments such as Treasury Inflation-Protected Securities (TIPS), CDs, and bonds. These pay you a guaranteed return on your investment above the rate of inflation that we see in our economy today. Typically, they have lower yields than regular money market instruments. However, when you consider that they partially insulate your portfolio from the effects of inflation, their yield is worth far more than its face value. For example: Let's suppose we invest $10,000 in a CD paying 3% per year over 5 years with an inflation rate of 2%. At first glance, it may seem like we're not doing too well because we're earning only 3% per year. However, when you take into account the fact that inflation over this period is expected to be about 2%, we're actually doing better than if we were invested in a regular savings account paying 1%. This is because while $10,000 could have bought us $11,000 worth of goods 5 years ago, it will cost us around $12,500 today (due to inflation). So while CDs and TIPs typically have lower yields, they're still valuable tools for insulating our portfolio from the effects of inflation. ConclusionIf you're looking for hedging against inflation, consider investing in treasury bonds. The easiest way to do this is by purchasing an index fund that invests in a basket of Treasury securities (like the Vanguard Total Bond Market Fund ETF) and holds them until maturity. Article Source Here: How to Hedge Inflation? Covered bonds are a type of debt instrument that is issued by a bank. These types of securities have two main features, which are: the issuer has pledged its assets to back up payments on the bond, and investors can buy these bonds at lower yields than other comparable instruments because they get paid if there's an issue with the borrower. In this article, we are going to take a look at what covered bonds are and how they actually work. Definition of Covered BondsCovered bonds are generally characterized as being long-term debt securities that are issued by banks. They can be either secured or unsecured, and they pay out interest over time with the goal of helping to provide liquidity for issuing banks. Overall, covered bonds are perfect for spreading risk between investors and issuers, because the former will receive their income as long as the issuer hasn't defaulted or failed to pay. This helps reduce the risk for both parties. Benefits of Covered BondsThere are a number of benefits that covered bonds offer to both investors and issuers. For example, these types of securities are considered relatively safe when compared to other types of debt instruments like mortgages or loans. This is because they can't be traded on the secondary market. And in case there's an issue with the borrower, then investors will get their payments. The risk management goals of covered bonds are also a good thing for investors. And these can even help to lower the cost of funds and raise capital for a bank or other financing institution that issues them. In short, covered bonds provide borrowers with cheaper funding sources that can be used to make new loans or otherwise improve liquidity in the market. As said above, covered bonds are considered a safe investment because they have more collateral backing them up than other types of debt instruments. In this respect, the European Investment Bank (EIB) has mostly financed covered bond banking projects throughout Eurozone countries. How do Covered Bonds Work?Covered bonds work in a very similar way to how normal corporate bonds work. However, unlike standard bonds that can be freely traded on the secondary market, covered are only eligible for redemption from the issuing bank at the maturity date of these instruments. This is only possible if investors have actually been paid their interest and received principal payments (if due). The main difference between covered and normal bonds is that the former have assets under them as collateral. This provides investors with a greater level of security in case there's a payment issue. And this also helps to bring down the cost of funds for issuing banks. So as you can tell, there are a lot of advantages to both investors and lending institutions. But this doesn't mean that covered bonds aren't without their drawbacks. For example, they have a relatively low liquidity level (compared to normal corporate bonds). This is because they can only be sold back to the issuer at the end of their term period. ConclusionOverall, covered bonds are great for spreading risk between issuers and investors because the former gives up assets that can be used to back these instruments up in case there's a payment issue. And this provides investors with a greater safety net than they would normally have with other types of debt instruments. Originally Published Here: What is a Covered Bond? Pairs trading is a classic “market-neutral” trading strategy. Previously, we highlighted an article that claims that cointegration is a superior method for selecting pairs [1]. Reference [2] examined more pair selection methods. Specifically, it investigated the following approaches,
It concluded, contrary to Reference [1], that the best method for selecting pairs is the distance method. Cointegration is the second-best one only. Note that the results are applicable to the Finnish stock market. This thesis confirms the assumptions made in previous literature about what types of pairs are suitable for pairs trading. When pair formation is limited to allow only pairs consisting of companies from the same industry, distance-based and cointegration-based selection favors pairs formed of different share classes of one company. An example of this is Orion Class A- Orion Class B. Such pairs provide more trading opportunities than other types of pairs (e.g. Stora Enso - UPM). Although 2 articles are contradictory, we believe that:
References [1] N. Huck and K. Afawubo, Pairs trading and selection methods: is cointegration superior?, Applied Economics, 47:6, 599-613, 2015 [2] S. Kohvakka, Pairs trading revisited - the case of OMX Helsinki, Lappeenranta-Lahti University of Technology LUT, 2020 Post Source Here: Is Cointegration the Best Method for Pairs Trading? |
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