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E D H E C R I S K A N D A S S E T M A N A G E M E N T R E S E A R C H C E N T R E E D H E C A L T E R N AT I V E I N D E X E S M A R C H 2 0 0 4 1090, ro ute de s Cr te s So phia -Antipo lis 06560 Va lb o

  1. E D H E C R I S K A N D A S S E T M A N A G E M E N T R E S E A R C H C E N T R E E D H E C A L T E R N AT I V E I N D E X E S M A R C H 2 0 0 4

  2. 1090, ro ute de s Crê te s So phia -Antipo lis 06560 Va lb o nne T é l. : +33 (0)4 92 96 89 50 F a x : +33 (0)4 92 96 93 22 r e se a rc h@ e dhe c -risk.c o m www.e dhe c - r isk.c om T his do c ume nt has b e e n pub lishe d with the suppo rt o f Alte ram E dhe c is o ne o f the to p five b usine ss sc ho o ls in F ra nc e o wing to the hig h q ua lity o f its a c a de mic sta ff (90 pe rma ne nt le c ture rs fro m F ra nc e a nd a b ro a d) a nd its privile g e d re la tio nship with pro fe ssio na ls tha t the sc ho o l ha s b e e n de ve lo ping sinc e its e sta b lishme nt in 1906. E dhe c Busine ss Sc ho o l ha s de c ide d to dra w o n its e xte nsive kno wle dg e o f the pro fe ssio na l e nviro nme nt a nd ha s the re fo re c o nc e ntra te d its re se a rc h o n the me s tha t sa tisfy the ne e ds o f pro fe ssio na ls. E dhe c imple me nts a n a c tive re se a rc h po lic y in the fie ld o f fina nc e . T he E dhe c Risk a nd Asse t Ma na g e me nt Re se a rc h Ce ntre c a rrie s o ut nume ro us re se a rc h pro g ra ms in the a re a s o f a sse t a llo c a tio n a nd risk ma na g e me nt in b o th the tra ditio na l a nd a lte rna tive inve stme nt unive rse s.

  3. T ABL E OF CONT E NT S 7 I. T HE HE T E ROGE NE IT Y AND BIASE S OF AL T E RNAT IVE INDE XE S T he Bia se s o f He dg e F und I nde xe s 7 T he Pe rfo rma nc e He te ro g e ne ity o f He dg e F und I nde xe s 9 11 II. E DHE C AL T E RNAT IVE INDE XE S CONST RUCT ION AND MANAGE ME NT PRINCIPL E S Princ ipa l Co mpo ne nt Ana lysis 11 L ist o f E dhe c Alte rna tive I nde xe s a nd the ir c o nstitue nts 12 Ba c kfilling Pro c e ss 13 Upda ting Pro c e ss 13 E dhe c I nde xe s Pre limina ry Re turns 15 E dhe c I nde x Adviso ry Bo a rd 16 17 III. T HE PROPE RT IE S OF E DHE C AL T E RNAT IVE INDE XE S T he Re pre se nta tivity Dime nsio n 17 T he Sta b ility o f E dhe c Alte rna tive I nde xe s 18 19 IV. USE OF E DHE C INDE XE S F OR PORT F OL IO MANAGE ME NT T he T ra c ka b ility o f E dhe c Alte rna tive I nde xe s 19 E dhe c Alte rna tive I nde xe s in the Stra te g ic Allo c a tio n Pro c e ss 20 NDIX 1: De finitio n o f He dg e F und Style s 22 APPE NDIX 2: Princ ipa l Co mpo ne nt Ana lysis 24 APPE NDIX 3: Pe rfo rma nc e o f E dhe c Alte rna tive I nde xe s 26 APPE 3

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  5. I E XE CUT IVE SUMMAR Y Alte rna tive inve stme nt c urre ntly re pre se nts ne a rly 700 b illio n do lla rs in ma na g e d a sse ts. I nstitutio na l inve sto rs' inc re a sing inte re st in a lte rna tive inve stme nt c o nfirms the fa c t tha t it is ra pidly b e c o ming pa rt o f ma instre a m a sse t a llo c a tio n de c isio ns. At the e nd o f 2002, 52% o f the a sse ts ma na g e d b y a lte rna tive funds c a me fro m institutio na l so urc e s (c o mpa re d to o nly 19% in 1992). T he ma ssive inflo w o f c a pita l (+60% in 2000 a nd +40% in 2001) ha s thus b ro ug ht a n e nd to the re la tive ly c o nfide ntia l na ture o f a lte rna tive inve stme nt stra te g ie s, whic h c a n no lo ng e r re a so na b ly b e c o nside re d to b e a ma rg ina l a c tivity within the a sse t ma na g e me nt industry. Ma jo r a sse t ma na g e me nt ho use s e xpe c t tha t the lo ng -te rm g ro wth ra te o f a sse ts unde r ma na g e me nt b y he dg e funds sho uld b e a ro und 15%. T he re a re ho we ve r a numb e r o f o b sta c le s to the industria liza tio n o f the a lte rna tive inve stme nt industry. I ts a do ptio n b y institutio na l inve sto rs will o nly c o me a b o ut if a se rio us e ffo rt is ma de in te rms o f tra nspa re nc y a nd ra tio na liza tio n o f the inve stme nt ma na g e me nt pro c e ss a nd, a b o ve a ll, pe rfo rma nc e e va lua tio n. Due to the sc a rc ity o f info rma tio n, the lo g ic o f re pre se nta tive ne ss thro ug h ma rke t c a pita liza tio n is diffic ult to a pply to the a lte rna tive unive rse . As a re sult, finding a b e nc hma rk tha t is re pre se nta tive o f a pa rtic ula r ma na g e me nt unive rse is no t a trivia l pro b le m. T he diffe re nt inde xe s a va ila b le o n the ma rke t a re c o nstruc te d fro m diffe re nt da ta , a c c o rding to dive rse se le c tio n c rite ria a nd me tho ds o f c o nstruc tio n, a nd the y e vo lve a t diffe ring pa c e s. As a re sult o f this he te ro g e ne ity, inve sto rs c a nno t re ly o n c o mpe ting he dg e fund inde xe s to o b ta in a “true a nd fa ir” vie w o f he dg e fund pe rfo rma nc e . I nve sto rs a re the re fo re a t a lo ss whe n se le c ting b e nc hma rks. As a re spo nse to the ne e ds o f inve sto rs, the E dhe c Risk a nd Asse t Ma na g e me nt Re se a rc h Ce nte r pro po se s a n o rig ina l so lutio n b y c o nstruc ting a n “inde x o f inde xe s.” T he a im o f the me tho do lo g y use d to c o nstruc t this “inde x o f inde xe s” is to c o nstruc t a b e nc hma rk with de g re e s o f re pre se nta tivity a nd sta b ility tha t a re sig nific a ntly hig he r tha n tho se o f the inde xe s a va ila b le o n the ma rke t. T his me tho do lo g y wa s first intro duc e d in Ame nc , Ma rte llini (2003) 1 . T he sta tistic a l pro c e ss le a ding to the c o nstruc tio n o f the “inde x o f inde xe s” (i.e ., the E dhe c Alte rna tive I nde xe s) g ive s the m inte re sting po rtfo lio pro pe rtie s. T he se inde xe s impro ve the so undne ss o f the stra te g ic a llo c a tio n pro c e ss a nd the y c a n b e re plic a te d mo re e a sily. He nc e , the E dhe c Alte rna tive I nde xe s a re ide a l c a ndida te s to he lp inve sto rs to a llo c a te a sig nific a nt pa rt o f the ir po rtfo lio to the a lte rna tive c la ss. L ist of E dhe c Alte r native Inde xe s and the ir Constitue nts as of Januar y 2004 Edhec Indexes HFR CSFB EACM Altvest Hennessee Van Hedge CISDM HF Net Barclay S&P Convertible Arbitrage X X X X X X CTA Global X X X X X Distressed Securities X X X X X X X X Emerging Markets X X X X X X X X Equity Market Neutral X X X X X X X Event Driven X X X X X X X X X Fixed Income Arbitrage X X X X X X Funds of Funds X X X X X X Global Macro X X X X X X X X Long / Short Equity X X X X X Merger Arbitrage X X X X X X X Relative Value X X X X X X X Short Selling X X X X X X X X X I nfo rmatio n availab le at www.e dhe c -risk.c o m 5 1 Ame nc , N., and Mar te llini, L ., 2003, T he Br ave Ne w Wo r ld o f He dge F und I nde xe s, Wo r king Pape r , E dhe c Risk and Asse t Manage me nt Ce ntr e .

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