Editor’s Letter

Within investments, there often seems a contest between how one approaches analysis of financial markets. While not going as far as Ying and Yang in terms of polar opposites, finance is often presented from a micro perspective in which the bottom-up, detailed understanding of a particular sub area of process dominates or is presented from a more top-down perspective in which the broad concerns of a process trump the day-to-day operational issues. In truth one can learn from both sides. In the first article in this issue, “Optimal Hedge Fund Allocation with Improved Estimates for Coskewness and Cokurtosis Parameters,” Asmerilda Hitaj, Lionel Martellini, and Giovanni Zambruno address one of the micro issues of asset allocation within the alternative investment markets. Since hedge fund returns are often not normally distributed, strict mean–variance optimization techniques may not always be appropriate and may require optimization procedures incorporating higher-order moments of portfolio returns. In this context, optimal portfolio decisions involving hedge funds require not only estimates for covariance parameters, but also estimates for coskewness and cokurtosis parameters. Here, Hitaj, Martellini, and Zambruno find that the use of these enhanced estimates generates a significant improvement for investors in hedge fund.

Moving from the more micro elements of parameter estimation for hedge fund based mean–variance-efficient portfolios, the second article takes a more top-down view of the impact of hedge funds in the area of corporate governance. Shareholder activism by hedge funds became a major corporate governance phenomenon in the United States in the 2000s. In the second article, “The Rise and Fall (?) of Shareholder Activism by Hedge Funds,” John Armour and Brian Cheffins put the trend into context by introducing a heuristic device referred to as “the market for corporate influence” to distinguish the ex ante-oriented “offensive” brand of activism hedge funds engage in from the ex post-oriented “defensive” activism carried out by mutual funds and pension funds. They trace the rise of hedge fund activism and anticipate future developments, arguing in so doing that, despite the blow the 2008 financial crisis dealt to hedge funds, their interventions will remain an important element of U.S. corporate governance going forward.

Moving back to the micro aspects of asset class analysis, one must be reminded that in the final analysis, a portfolio of alternative investments is simply that, a portfolio of primary assets or derivatives assets based on those assets. An understanding of the basic pricing and return elements of the underlying asset and derivatives based on those assets is a requirement for any investor in the alternative investment area. During the recent financial crisis, dedicated short bias (DSB) hedge funds exhibited extremely strong results while many other hedge fund strategies suffered badly. Prompted by this recent episode, in the third article, “Dedicated Short Bias Hedge Funds: Diversification and Alpha during Financial Crises,” Ciara Connolly and Mark C. Hutchinson investigate DSB hedge fund performance using three different factor model specifications and both linear and nonlinear estimation techniques. The authors conclude that DSB hedge funds are a significant source of diversification for equity market investors and produce statistically significant levels of alpha.

In the fourth article in this issue, “Comparison of Futures Pricing Models for Carbon Assets and Traditional Energy Commodities,” Takashi Kanamura explores the classification of carbon futures, often considered to be a type of energy commodity futures from the energy-emission relationship, by examining the characteristics of carbon futures prices. The author presents a carbon futures price model reflecting the observed price characteristics found in previous empirical studies. The empirical analysis of EUA (EU allowance) futures prices traded on the European Climate Exchange (ECX) show that convenience yield of EUAs is negatively correlated with EUA price returns, which corresponds to the characteristics of the model presented in this article. The author also reports positive market prices of risk (MPR) for carbon assets in both short- and long-term observation periods, finding them to be different from energy commodities where the long-term MPRs are positive and the short- term MPRs are negative. He also examines the conditional correlations between EUA futures prices for contracts with different delivery dates, finding almost positive correlations that cannot empirically produce backwardation as often observed in energy commodity futures markets. Moreover he shows that the price–volatility relationship possesses a leverage effect (that is, a negative relationship between futures price and volatility) often observed in security futures markets rather than energy commodity futures markets. In addition, empirical studies using EUA futures option prices traded on the ECX show that carbon futures prices behave unlike energy commodity futures but like security futures in terms of a volatility smile. These empirical results regarding carbon futures prices also support a carbon futures price model characterization that is more similar to security futures than to energy commodity futures.

From the micro analysis of individual commodity futures (e.g., carbon), one may also approach the impact of a more generic futures market such as volatility futures. In the fifth article in this issue, “The Efficiency of the VIX Futures Market: A Panel Data Approach,” Athanasios P. Fassas and Costas Siriopoulos examine whether VIX futures prices are unbiased and efficient predictors of the VIX index. The particular empirical analysis differs from the usually applied tests in that it uses a panel estimation approach. Panel regression has several advantages as it offers more flexibility in modeling the efficiency of several futures contracts with over-lapping datasets. As a result, this methodology enables the authors to include all daily closing prices of VIX futures contracts that expired between May 2004 and December 2009, a total of 64 contracts. The empirical findings support the hypothesis that VIX futures are good predictors of spot VIX values. The tests show that the VIX futures with a forecast horizon up to 23 days do not incorporate a significant risk premium and, thus, can be considered as unbiased and efficient estimators of the relevant spot VIX levels.

In the final two articles, we again center on understanding the specifics of a particular asset class (in this case real estate) and on a review of a more general approach to the understanding of another alternative asset class (clean tech private equity). In the sixth article, “Private and Public Real Estate: What Is the Link?” Dan Stefek and Raghu Suryanarayanan focus on equity investment in core real estate in the U.K. market, analyzing data spanning more than two decades. They demonstrate a strong link between the returns to public and private real estate by correcting for appraisal smoothing and for the lead–lag relationship between public and private returns. They also discuss how real estate risk changes over longer horizons. In particular, the correlation between private and public returns strengthens as the investment horizon increases. These results have important implications for both risk management and asset allocation. As an example, they illustrate how the diversification benefits of real estate depend on the investment horizon and the amount of leverage employed.

In the final article, “Five Perspectives on an Emerging Market: Challenges with Clean Tech Private Equity,” Eric R.W. Knight offers a perspective on some of the challenges in the industry. It relies on case studies drawn from 35 interviews with leading clean tech investment managers from Silicon Valley, New York, and London. The findings suggest that despite the long-term growth opportunities, investors continue to struggle to find attractive risk–reward premiums in early stage investments.

This issue has provided a series of articles, each of which has taken a more top-down or bottom-up approach in investment analysis in the alternative investment area. As important, is the realization that each of the above analyses provides a perspective that is contingent on the asset or market analyzed, or the process used (systematic algorithmic or discretionary), for the means one uses to describe a market opportunity. Six months, one year, or longer, each of the above articles while correct in its own time and place may be then regarded as preliminary rather than offering a more current understanding of market conditions. Such is the Ying and Yang of research.

May the force be with you, and we look forward to each and every submission.

Thomas Schneeweis

Editor

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