Portfolio Optimization

Project 2
FIN 653
Professor Natalia Gershun
Group Members:
Reynold D’silva
Hanxiang Tang
Wen Guo
Deliverable 1: Strategy 4 & 7
1)Credit Suisse Equity Market Neutral Hedge Fund Index:
The Credit Suisse All Hedge Equity Market Neutral Index is a subset of the Credit Suisse All
Hedge Index that measures the aggregate performance of equity market neutral funds. Equity
market neutral funds typically take both long and short positions in stocks while seeking to
reduce exposure to the systematic risk of the market (i.e., a beta of zero is desired). Equity
Market Neutral funds typically seek to exploit investment opportunities unique to a specific
group of stocks, while maintaining a neutral exposure to broad groups of stocks defined for
example by sector, industry, market capitalization, country, or region. The index has a number
of subsectors including statistical arbitrage, quantitative long/short, fundamental long/short
and index arbitrage. Managers often apply leverage to enhance returns.
What is the goal of the strategy?
The goal here is to minimize exposure to risk. The aim is to find stocks with correlation of -1. It
usually does not involve risk free assets as it affects the overall returns of the portfolio.

Which financial instruments and which positions (long, short) these strategies use to
accomplish this goal?
After in-depth analysis, stocks from a particular industry which are expected to be over-valued
are short-sold and under-valued are longed. This strategy is used mostly on stocks from a
particular industry to decrease the risk quotient. It can also be implemented on a stock and
derivative contract of futures.

What are the market conditions in which each strategy is expected to make (loose)money?
This strategy is averse to the movement of the market. Sometimes its hedged against the market.
To illustrate, gold futures is a good hedge against the stock market.

Provide a simple example of the strategy?

Pairs trading is a famous strategy in this spectrum. It can also be used for day-trading. Longing
Citibank and Shorting JP Morgan can be a good example.

2) Credit Suisse Event Driven Multi-Strategy Hedge Fund Index:

The Credit Suisse All Hedge Event Driven Index is a subset of the Credit Suisse All Hedge Index
that measures the aggregate performance of event driven funds. Event driven funds typically
invest in various asset classes and seek to profit from potential mispricing of securities related
to a specific corporate or market event. Such events can include: mergers, bankruptcies,
financial or operational stress, restructurings, asset sales, recapitalizations, spin-offs, litigation,
regulatory and legislative changes as well as other types of corporate events. Event driven
funds can invest in equities, fixed income instruments (investment grade, high yield, bank debt,
convertible debt and distressed), options and various other derivatives. Many managers may
use a combination of strategies and adjust exposures based on the opportunity sets in each
subsector.
What is the goal of the strategy?
The goal is to make profits on current events like Mergers, Acquisition, Change in Management,
Rate Hike etcetera. Hedge fund managers try to assess market sentiment before the occurrence of
the event and if successful, make windfall gains.

Which financial instruments and which positions (long, short) these strategies use to
accomplish this goal?
After analyzing a particular event, if the fund manager thinks that a particular event like change
in management shook investor confidence and created a negative sentiment but the company still
has strong fundamentals, he may buy its stocks and vice versa.

What are the market conditions in which each strategy is expected to make (loose)money?
This strategy is averse to the movement of the market. Sometimes it is executed in tandem with a
market related event like Rate Hike. In this case, if the fund manager feels that the rate is going
to increase, he may long dollar-indexed futures.

Provide a simple example of the strategy?

Arbitrage trading could be a classic example. Mispricing is the crux of this strategy and
algorithmic arbitrage can be an effective tool for this type. Arbitrage is widely utilized in
currency trading due to the plethora of events affecting individual currencies thereby giving an
opportunity for event-driven investors

Deliverable 2:
II. Analysis of Past performance The main goal of this part of the project is to use data on past
returns to estimate mean returns, and the variance-covariance matrix of the assets in your
portfolio. Deliverable 2: 1) Using commands in the Excel Functions menu (click on fx button),
calculate expected monthly returns on all assets (use AVERAGE function). 2) Annualize your
expected returns. It means that you need to multiply monthly returns by 12. Arrange
annualized returns in one row (12 cells).
Avera
ge - -
Month 0.33 0.80 0.33 0.17 0.29 0.31 0.29 0.25 0.29 0.45 0.33 0.29
ly % % % % % % % % % % % %
Annua -
lly 4% 10% 4% -2% 3% 4% 3% 3% 3% 5% 4% 3%

Deliverable 3:
 1) This is the monthly data calculated through the plug-in on Blackboard. The premise
behind this calculation is to check the volatility of individual data-sets. This will be
further converged into annual sets to trim futile amounts of data without losing
precision of the analysis.

2) This is annual variance table derived from the monthly data. The premise behind calculating
this is to reduce the size of the given data with least deviation. This is calculated by multiplying
the monthly data by 12.
Deliverable 4:
1) This is the monthly Variance/Covariance matrix. This is derived from the given data of
12X12 index data. This is further annualized to fine-tune the analytical process.

2) This is the Annualized Variance/Covariance matrix. The reason behind annualizing the
returns is to streamline the calculation and standardize the analytical procedure.
Deliverable 5:
These are the set of weights calculated by Solver by setting Variance as objective. This helps to
make decisions on the allocation of resources in the 12 indices.

Deliverable 6:
This table is the Standard Deviation and Expected Return done by running Solver 10 times to
get different sets of data. The goal here was to observe the trajectory of returns based on the
increasing standard deviation.

Deliverable 7:
This is the efficient frontier of the incremental Standard Deviation (1%) and Expected Return
which was calculated in Deliverable 6. The frontier suggests that inspite of the higher variance,
the profit increases due to efficient diversification of risk.
Deliverable 8:

Deliverable 9:
Here you see the efficient portfolio of the 12 indices and S&P 500-
Hedge fund
monthly return return
0.0158418 0.0057
0.0240822 -0.0060
0.0126812 0.0160
0.0377092 0.0234
0.0102519 0.0175
-0.0067989 0.0118
-0.0090885 0.0041
0.0132998 0.0002
0.0311965 0.0022
0.008879 0.0037
-0.0048132 0.0035
0.0265041 0.0044
0.0617143 0.0009
-0.0073908 0.0258
-0.0659565 0.0052
-0.0127558 0.0075
 0.0275631 -0.0075
0.0413547 0.0016
-0.046802 0.0015
-0.0259152 -0.0083
-0.0024485 -0.0029
-0.0059945 0.0039
0.0081533 -0.0098
0.0071491 0.0016
-0.0010614 0.0100
0.0266347 -0.0042
-0.0127004 -0.0002
0.0047443 -0.0002
0.0553872 -0.0182
-0.028075 -0.0058
0.0161609 -0.0009
-0.0058639 -0.0092
0.0133584 0.0121
0.0303317 0.0132
0.0136837 0.0088
0.0003971 0.0078
0.0255857 0.0053
-0.0029248 0.0078
0.0080651 0.0089
0.0135909 0.0039
0.0369238 0.0049
0.0194764 0.0113
0.010227 -0.0073
0.000845 0.0135
0.0308321 -0.0001
-0.0128488 0.0137
0.0440186 0.0126
0.0128125 0.0118
0.025471 0.0099
0.021555 -0.0089
0.0408566 0.0133
0.019921 0.0082
-0.030122 -0.0033
-0.0038797 0.0075
0.0284871 0.0051
0.0321081 0.0072
0.0274277 -0.0002
-0.0132635 -0.0019
-0.0325729 0.0011
-0.0020227 0.0129
0.0271721 0.0075
0.039913 0.0050
0.0460541 0.0038
0.0137882 0.0046
0.015896 0.0082
0.0284015 0.0115
-0.009643 0.0046
-0.1055479 0.0008
0.0294339 0.0029
-0.0381227 -0.0031
0.005107 0.0189
0.0207131 0.0004
-0.0125878 0.0108
0.0300167 0.0086
0.0330963 0.0200
0.0355662 -0.0061
0.0233104 -0.0038
0.0441145 0.0221
0.0320065 0.0032
0.0069272 0.0056
-0.0032861 -0.0005
-0.0370647 -0.0038
-0.0603515 0.0101
0.0392952 0.0028
0.0577417 0.0108
-0.0306342 0.0166
0.0118878 -0.0017
0.0205042 0.0272
0.0191166 -0.0012
0.0221244 0.0168
0.0344947 0.0112
0.0789682 0.0080
0.0104738 0.0022
0.0262741 0.0033
0.0639745 -0.0055
0.1202171 0.0086
-0.0597345 0.0115
-0.069722 -0.0017
-0.0136515 0.0049
-0.0062058 0.0082
-0.0885219 -0.0245
-0.2039507 -0.0239
 -0.0503016 0.0022
0.0191994 -0.0096
-0.0625685 0.0048
-0.0441627 0.0009
0.0238969 0.0038
0.0406473 0.0131
-0.0279953 0.0188
-0.0173272 0.0232
-0.0679205 -0.0023
0.0108242 -0.0063
-0.0495369 0.0052
0.0284146 0.0268
0.0292173 -0.0028
-0.0434537 -0.0065
0.0041004 0.0013
0.0022169 0.0111

Deliverable 10:
Solver states that S & P 500 should be short-sold(weight is in minus i.e -0.01018) while the
efficient portfolio should be longed. Also, the allocation is much larger in the portfolio due to
low risk content.
Deliverable 11:
The addition of the hedge fund portfolio considerably reduced the variance which in turn
reduced the overall risk. While making investments for long or short-term, Investors always
look out for high premium and preferably low volatility. A portfolio with a low standard
deviation would result in minimizing the risk which would improve the return prospects of the
investment and hinder trajectory deviation.