Monday, June 2, 2014

McCann, Tactical Portfolios

Bailey McCann, a member of the Opalesque news and research team, introduces readers to the complex world of hedge funds in Tactical Portfolios: Strategies and Tactics for Investing in Hedge Funds and Liquid Alternatives (Wiley, 2014). In this task she had help from Benedicte Gravrand and Mark Melin, who wrote the chapters on emerging managers and managed futures, respectively. The book also includes lengthy inserts by experts in the field.

This is essentially a “how” and “how to” book—how hedge fund strategies work and how to approach investing in hedge funds (investment structures, service providers, due diligence, and investment mechanics). It also has a chapter on regulatory regime changes and impact, both in the US and the EU. One of the strengths of the book is that it takes readers beyond the borders of the United States.

Let’s look briefly at one very simple portfolio hedging strategy that even retail investors could implement: using quantitative trend following as an equity risk hedge. Unfortunately, in recent years “trend following managers have reduced their core style exposures and increased risk-on trades, which have a greater correlation to equities.” (p. 172) Moreover, for some years trend followers have benefited from using fixed income as a means of cheap equity hedging, but “this may not be the case indefinitely.” In fact, according to the authors of the TF study quoted extensively in the text, “The market environment is primed for a major change to happen because volatility is compressed and the skew is very negative.” (p. 173) Investors looking for a better equity hedge might consider “working within classical trend following strategies such as the 10-day to 100-day simple moving average crossover.” The study’s authors propose a “covariance filter on TF trades to accept only trades that have negative covariance to equities.” In this way, “investors can realize the equity hedge they hope for from CTAs, while realizing alpha. This approach also sets the strategy apart from tail-risk strategies, which are typically negative carry until a significant correction.” (p. 175)

Tactical Portfolios has something of a scattershot feel to it, which makes it a poor choice for the novice wanting to learn about hedge fund investing. But more sophisticated readers who are willing to pick their way through the book will undoubtedly find some useful information.

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