Recent Research: Highlights from October 2010

“An Examination of Traditional Style Indices.” The Journal of Index Investing (Fall 2010). Jason Hsu, Vitali Kalesnik, and Himanshu Surti.

For investors using a core–satellite approach to strategic asset allocation, traditional style indices, such as value and smallcap indices, represent convenient passive vehicles for achieving strategic or even tactical portfolio tilts. In this article, the authors examine traditional style indices using the Fama–French three-factor analysis. They find that most of the style indices exhibit a negative Fama–French alpha and statistically conclude that traditional style indices are suboptimal means for creating style tilts in portfolios. They posit that the source of the sub-optimality comes from the capweighted construction methodology, which these indices are rooted in and demonstrate that using a simple non-priceweighted approach for creating the style indices would result in more efficient exposures.

“Insurance-Linked Securities: What Drives Their Returns?” The Journal of Alternative Investments (Fall 2010). Lars Jaeger, Stephan Müller, and Samuel Scherling.

In this article, insurance-linked securities (ILS) are identified as a source of alternative beta. Against the payment of a risk premium, investors assume natural catastrophe and other insurance risks. Not only is the ILS risk premium generally relatively generous in comparison to the probability of loss, but, more importantly, the occurrence of an earthquake or hurricane event is independent from financial market events. This offers attractive opportunities for diversification.

While the story of ILS being an advantageous addition to most investment portfolios is easily and convincingly told, there remains considerable market confusion about the precise identity and characteristics of ILS return drivers. The aim of this article is to address this and related questions, decompose ILS return into various return sources, distinguish between their alpha and beta parts, and analyze each in detail.

“Ten Questions Every Institution Should Ask Their Dark Pool Providers.” The Journal of Trading (Fall 2010). Jay Bennett, John Colon, John Feng, and Jennifer Litwin.

In July 2008, Greenwich Associates surveyed 64 institutional investors that described themselves as active users of dark pools in North America and Europe to ask them about their practices, experiences, and intentions with regard to these emerging trading venues. The results revealed a significant proportion of institutional investors were “in the dark” about certain policies and practices of the broker-dealers and exchanges that provide dark liquidity. To help investors get the most out of these increasingly important trading venues—and to avoid costly mistakes—the authors compiled a list of 10 important questions that institutions should ask their broker-dealers and exchanges.

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