Journal of Investment Strategies

Welcome to the fourth issue of the eighth volume of The Journal of Investment Strate- gies. In this issue, you will find three papers: one that discusses the portfolio management of Commodity Trading Advisors (CTAs); one that examines the pricing of firm-specific risk in emerging markets; and one that covers a trading strategy that connects equity and foreign exchange (FX) markets through World Market Reuters (WM/Reuters).
“Portfolio management of Commodity Trading Advisors with volatility-targeting” by Marat Molyboga, the issue’s first paper, demonstrates analytically that a volatility- targeted allocation methodology improves the risk-adjusted performance of port- folios under a broad set of assumptions regarding the serial correlation of returns and the dependence of the expected Sharpe ratio on the level of volatility. Here, the author has empirically examined the impact of volatility-targeting on portfolios of CTAs within the large-scale simulation-based methodology proposed by Molyboga and L’Ahelec for evaluating hedge fund investments, which accounts for the real world constraints on institutional investors. He finds a consistent and statistically significant improvement in the out-of-sample returns that ranges between 0.53% and 0.80% per annum, on average. The performance enhancement is robust to portfolio size and manager selection, and it is implementable inside managed account investments.
The theoretical framework of this research and the empirical methodology may be broadly applied to determine whether volatility-targeting can improve the performance of multimanager portfolios of hedge funds and mutual funds.
In our second paper, “The pricing of firm-specific risk in emerging markets”, Hilal Anwar Butt and Mohsin Sadaqat find that a zero-investment strategy that goes long (short) in the highest (lowest) quintiles of firm-specific risk earns overall positive excess returns across twenty-one emerging markets. Interestingly, in previous studies such returns were found to be negative for the US and developed markets. Nevertheless, the risk-adjusted alphas of the capital asset pricing model (CAPM), the Fama–French three-factor model and the Carhart four-factor model are mostly negative for a number of emerging markets. Thus, the puzzling negative premiums associated with firm-specific risks are ultimately reconciled across global equity mar- kets. The impetus for such negative premiums is primarily given by the firms with the lowest firm-specific risk, as these firms are hedged against market-based risks and have significant positive alphas.
This study contributes to the debate regarding the pricing of firm-specific risk by incorporating the evidence of emerging markets. Their results support the notion that firms with higher firm-specific risk have, on average, higher returns than firms with lower firm-specific risk.
In our third paper, “Connecting equity and foreign exchange markets through  the WM ‘Fix’: a trading strategy”, Arnav Sheth and Keisuke Teeple examine the relationship between equity and FX markets at and around the WM/Reuters bench- mark exchange rate known as the “Fix”. Execution at the Fix is a service offered by brokers, provided they obtain the trade order before 16:00 GMT.
The authors show the connection between equities and FX markets via this window, leverage this connection using an algorithmic trading strategy, and rank various statistical techniques used to make predictions for trading based on their investment results. The best technique produces an out-of-sample annual cumulative return of 4.02% and an annualized Sharpe ratio of 3.43. The strategy presented is solely for illustrative purposes.
Whether or not this is repeatable for different years is left by the authors for future research. They are currently looking into utilizing machine learning for other statistical techniques to rank and compare equities and FX markets.
On behalf of the editorial board, we would like to thank our readers for their continued support of and keen interest in The Journal of Investment Strategies. We look forward to sharing with you the growing list of practical papers, on a broad variety of topics related to modern investment strategies, that we continue to receive from both academics and practitioners.

Arthur M. Berd
Founder and CEO, General Quantitative LLC

Ali Hirsa
Managing Partner, Sauma Capital LLC & Professor, Columbia University