TAILIEUCHUNG - Commodity Trading Advisors: Risk, Performance Analysis, and Selection Chapter 11

CHAPTER 11 Managing Downside Risk in Return Distributions Using Hedge Funds, Managed Futures, and Commodity Indices. This chapter examines how alternative investments can provide downside return protection in a portfolio composed of . stocks and bonds. | 11 Managing Downside Risk in Return Distributions Using Hedge Funds Managed Futures and Commodity Indices Mark Anson This chapter examines how alternative investments can provide downside return protection in a portfolio composed of . stocks and bonds. Adding active skill-based strategies such as hedge funds or managed futures to the portfolio leads to important improvements in downside returns Sharpe ratio and cumulative performance improvement often without reducing upside expected returns. In some cases the same benefits can be realized by adding passive commodity futures indices instead of skillbased strategies. INTRODUCTION Every investor is concerned with downside risk management. This is why diversification is a uniform portfolio tool. The better diversified an investment portfolio presumably the less the portfolio is exposed to months where the return is negative. Yet it is an unfortunate fact of life that when things hit the fan they tend to do it all at the same time. For example a number of studies have examined the correlation of the . domestic and international equity markets during periods of market stress or decline. The conclusion is that the equity markets around the world tend to be more highly correlated during periods of economic stress. See Erb Harvey and Viskanta 1994 220 Managing Downside Risk in Return Distributions 221 Sinquefield 1996. Therefore international equity diversification may not provide the requisite diversification when a . domestic investor needs it most during periods of economic turmoil or decline. The equity markets have become a single global asset class for four reasons. 1. Policymakers from major industrial nations regularly attend economic summits where they attempt to synchronize fiscal and monetary policy. The Maastricht Treaty and the birth of Euroland is an example. 2. Corporations are expanding their operations and revenue streams beyond the site of their domestic incorporation. 3. The increased volume of

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