Alpha2 - Enhanced Hedge Fund Index Solution
Alpha Generation via Tactical Hedge Fund Index Allocation




GOAL
  • To maximize the risk-adjusted total return of a diversified portfolio of hedge fund sub-indices by actively overweighting and underweighting the components of the strategic portfolio

KEY PRODUCT DIFFERENTIATING FACTORS
  • Innovative Solution: Alpha to be generated over and above Credit Suisse/Tremont investable hedge-fund index based on statistical evidence of the predictability in hedge fund sub-index returns
  • Transparent Quantitative Process: A disciplined approach based on robust quantitative processes from initial long-term derivation of long-term optimal weights to the derivation of tactical alpha tilts
  • Optimal Portfolio Construction: Equilibrium portfolio weights to be devised so as to meet investor’s objectives i.e. low correlation to traditional asset classes, maximum expected information ratio, low drawdown risks, or a combination of non-mutually exclusive objectives and constraints.
  • Market and economic intuition: Signals driving alpha tilts to be based on systematic risk factors, consistent with market and economic intuition

THREE STEPS CONSTRUCTION PROCESS

1. Strategic Allocation: A disciplined and robust portfolio construction framework based on state-of-the-art risk quantification and management techniques
    • Application of correction techniques to overcome biases associated with hedge fund sub-indices
    • Non-linear dependence techniques to be applied to generate optimal equilibrium hedge fund basket weights (Rank Correlations, Copulas)
    • Equilibrium portfolio allocations to be derived incorporating several predefined risk criteria and to be assessed with multiple methodologies (Reverse Mean-Variance optimization, Value at Risk (VaR) and modified VaR, Copula/Extreme Value Theory optimizations)
    • Optimal allocation to include all predefined investor specifications and risk preferences

2. Tactical views and alpha generation: An innovative and transparent approach to focus on higher risk-adjusted opportunities

    • Consistent incorporation of multiple dimensions of information including significant exogenous indicators and systematic risk factors
    • Parsimonious number of signals are applied to all relevant sub hedge-fund indices
    • Signals’ sensitivities to be dynamically adjusted according to their explanatory power
    • Direction and confidence of resulting tactical views expressed in expected mean and standard error
3. Disciplined and robust portfolio construction framework
    • Tactical views to be integrated at the final portfolio optimization step, where strategic and tactical views are to be apportioned according to model derived associated confidence levels
    • Final optimization: To include all investor preferences (orthogonality to traditional asset classes, long-only and no leverage restrictions).
    • Flexible control of position turnover via a transaction penalty parameter
    • Risks associated with final solution to be consistent with following predefined bounds: maximum acceptable loss assessed via stress-tests, VaR, mVaR, and EVT parameters

OVERVIEW 
  • Initial objectives and constraints
    • The objective is to consistently out-perform the benchmark portfolio while staying within the prescribed risk limits 
    • No short selling or leverage is permitted in the overall portfolio
  • Coverage includes CS/Tremont’s 10 main hedge fund indices:
    • Convertible Arbitrage Index 
    • Dedicated Short Bias Index 
    • Emerging Market Index 
    • Equity Market Neutral Index 
    • Event Driven Index 
    • Fixed Income Arbitrage Index 
    • Global Macro Index 
    • Long/Short Equity Index 
    • Managed Futures Index 
    • Multi-Strategy Index
  • The Alpha2 model selects from 95 exogenous signals:
    • Approach based on statistically sounds methodologies
    • Exogenous signals and systematic risk factors are consistent with market and economic intuition
    • Capability to expand the approach to additional hedge fund sub-sector indices
  • The Alpha2 model offers an innovative and transparent approach to focus on profitable relative trades, allowing consistent incorporation of multiple dimensions of information advantage into the portfolio
    • At the individual hedge fund sub-sector strategy level: 
      • A parsimonious number of signals are chosen 
      • Weights of signals are dynamically adjusted 
      • Direction and confidence of profitable investment views are derived 
    • Across hedge fund sub-sector strategies: 
      • Strategic equilibrium weights and tactical investment views are blended through a Bayesian framework based on their relative information advantage 
      • Expected returns for all hedge fund sub-sectors are derived alongside their associated confidence levels
    • Portfolio construction: 
      • Tactical over/under-weights are determined based on return and risk tradeoff, given the benchmark, constraints, turnover and transaction costs considerations
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Alpha Squared - Enhanced Hedge Fund Index Solution - Alpha Generation via Tactical Style Tilts  574k v. 4 Nov 24, 2013, 1:45 AM QMS Advisors