There exists a quote, often attributed to Mark Twain, “thattruth dies easily but a lie well told, lasts forever.” Overthe past ten years, the alternative investment area has wit-nessed a paradigm shift in which hedge funds are no

longer viewed solely as ‘absolute return’ vehicles, but strategies inwhich a portion of the return is due to the strategies underlyingexposure to market risks including market volatility. The lead sec-tion features an article which further explores this issue. In the arti-cle, “Asset Based Style Analysis for Equity Strategies: The Role ofthe Volatility Factor,” David Kuenzi and Xu Shi examine the effec-tiveness of various volatility factors. Their results show that calls andputs on market indices provide intuitive measures of volatility withreasonably high levels of explanatory power for the variation inreturns in comparison to other volatility factors.

New ideas such as the use of various factor-based models tounderstand the alternative asset return process, does not of course,mean that traditional methods of return estimation or asset alloca-tion such as mean variance optimization do not play an importantrole. The next section features articles on Optimization Methods.In the second article, “Building a Hedge Fund Portfolio with Kur-tosis and Skewness,” Mark Anson, Ho Ho and Kurt Silbersteinincorporate skewness and kurtosis into the hedge fund selection pro-cess and apply it to a “live” portfolio of hedge funds. Their resultsshow that multi-moment optimizations produced superior portfo-lios with higher Sharpe Ratios while explicitly accounting for kur-tosis and skewness. In the third article, “Optimizing Benchmark-Based Portfolios with Hedge Funds,” Ivilina Popova, David P.Morton, Elmira Popova and Jot Yau introduce a new stochastic pro-gramming model which incorporates Monte Carlo simulation andoptimization to examine the effects on the optimal allocation tohedge funds given benchmark related investment objectives suchas expected shortfall and semi-variance. Their results show that asubstantial allocation—approximately 20% to hedge funds is justi-fied. They find that the return distributions of portfolios con-structed using the stochastic programming model skew to the rightrelative to those of the optimal mean-variance portfolios, resultingin higher Sortino ratios.

Changes in our understanding of both market factors explain-ing hedge fund returns or the implications of the use of traditional

VOLUME 10 NUMBER 1 SUMMER 2007

THOMAS SCHNEEWEIS EditorHOSSEIN KAZEMI Associate Editor

NOEL AMENC Associate EditorBHASWAR GUPTA Assistant Editor

HARRY KATZ Production and Technology Director

GWENDOLYN TOMASULO Marketing DirectorIAN AU Senior Marketing Manager

SHAUN BROUGH Head of SalesPETER JUNCAJ Head of Subscription Sales

SEGAL BENGIGI Account Manager

HASSAN BAKIRIDDIN Business Development ManagerElectronic Publishing

DEWEY PALMIERI Reprints Manager

ROBERT TONCHUK Director/Central Operations and Fulfillment

KELVIN LOUIE Senior Fulfillment ManagerCHERLY-NINA BONNY Fulfillment Manager

DAVID E. ANTIN Chief Operating OfficerSTEVE KURTZ Director, Finance & Operations

DAVID BLIDE Associate PublisherKATHERINE ARIAS Advertising Coordinator

ALLISON ADAMS PublisherCHRIS BROWN President

GARY MUELLER Chairman & CEO

by

gues

t on

Mar

ch 2

2, 2

020

Cop

yrig

ht 2

007

Page

ant M

edia

Ltd

. ht

tps:

//jai

.pm

-res

earc

h.co

mD

ownl

oade

d fr

om

2 THE JOURNAL OF ALTERNATIVE INVESTMENTS SUMMER 2007

mean variance processes in determining the value ofhedge fund returns should not hide the fact that formany, alternative investments cover a much broaderrange of investments. In fact, most ‘academic’ invest-ment books still discuss alternative investments as pri-marily representing investment in gold, silver, art andvarious forms of collectibles. The third section fea-tures an article on stamps as an investment strategy. Inthe fourth article, “Portfolio Diversification Benefitsof investing in Stamps,” Chris Veld And Yulia V.Veld-Merkoulova examine the benefits of investmentsin stamps to both U.K and U.S. investors using the SG100 index. The SG 100 index is an index of stampinvestments that was introduced by Stanley Gibbonsa large British stamp dealer in November 2002. Theirresults show that for a British (UK) investor thereturns on the stamp index are lower than for stockindexes such as the FTSE 100 and the FTSE 350.However for American investors, the unhedgedreturns slightly outperform returns on stocks.

The final section features articles on risk man-agement. Collateralized debt obligations (CDOs),first introduced into the financial markets in 1987, isan application of the securitization technology firstapplied to the creation of residential mortgage-backedsecurities. With annual issuance exceeding $100 bil-lion in 1998 CDOs were the fastest growing invest-ment vehicle of the last decade. In the fifth article,“Financial innovations and the Shaping of CapitalMarkets: The Case of CDO’s,” Douglas J. Lucas,Laurie S. Goodman, and Frank J. Fabozzi argue thatthe CDO market has become large enough to dom-inate the respective underlying collateral markets.They demonstrate this by examining three collateraltypes: high-yield loans, mezzanine mortgage asset-backed securities, and trust preferred debt. Theirresults show that issuance of CDOs backed by theseasset types has steadily increased and has lead to anincrease in the issuance of the underlying as well as

tightening of its spreads. In the last article, “EfficientTrees for CIR and CEV Short Rate Models” bySanjay K. Nawalkha and Natalia Beliaeva, we returnto the issue that we must constantly review previousconcepts and ideas. In this article, the author(s) pre-sent truncated-tree transforms for generating bino-mial and trinomial trees under the Cox, Ingersoll, andRoss (CIR) and constant-elasticity-of-variance (CEV)models of the short rate. They correct an error in theoriginal square root transform of Nelson andRamaswamy [1990], and modify their transform bytruncating the tree exactly at the zero-boundary.This not only allows for the creation of more efficienttrees for the CIR square-root process, but also for theentire class of CEV models of the short rate. The sim-ulations in this article show fast convergence andsignificantly improved performance of the truncated-tree approach over the Nelson-Ramaswamy approach.

As more and more articles are submitted toour Journal (and by our Journal I mean author(s) andreaders(s) alike), I am amazed by the speed by whichideas on the use of alternative investments are con-stantly evolving. A principal challenge for any Jour-nal is both to keep current with new concepts andtheories while keeping an appreciation for the his-torical viewpoints that provide the basis for ourunderstanding of alternative investments.

To understand, the process of change we, ofcourse, continue to depend on our readers and thosewho submit their ideas to the Journal. I have alwaysbelieved that there is an efficient market in ideas andthat sooner, rather than later, those ideas are broughtto the market place. I look forward to reading thoseefforts and to having the Journal continue as a pri-mary vehicle by which those ideas are presented.

Thomas SchneeweisEditor

by

gues

t on

Mar

ch 2

2, 2

020

Cop

yrig

ht 2

007

Page

ant M

edia

Ltd

. ht

tps:

//jai

.pm

-res

earc

h.co

mD

ownl

oade

d fr

om