EQIRA: Empirical and Quantitative Investment Research and Analysis

Understanding Eqira’s Factor-Based Projections

Abstract: It is very difficult to get reliable intra-month performance indications for alternatives such as hedge funds. Actual performance is typically reported monthly, often with considerable lag. The few daily indexes that do exist often exhibit enormous tracking error. This article examines the Eqira Factor-Based Projections and illustrates how they address these issues by providing reliable daily return estimates for 30 different hedge fund strategies and custom securities of our clients’ choosing.

The Problem

It is crucial for portfolio managers to know how their investments are performing, as market conditions are often critical information points in the investment decision making process. Fortunately, the rise of data providers such as Bloomberg and Yahoo! Finance have allowed market participants to easily track liquid investments, often in real-time. Unfortunately, there is still a sizeable portion of the investment universe that does not report performance frequently and for which few means exist for timely tracking.

Most of the alternatives space falls into this bucket. Hedge funds, for example, notoriously guarded and opaque, typically report performance monthly, often with delays ranging from a few days to a few weeks. Indexes, so crucial for benchmarking, suffer from even greater delays because they cannot complete their performance calculations until all funds have reported.

This creates problems for investors because it makes it difficult for them to react quickly during changing markets. They are likely to miss opportunities to capture gains or avoid losses simply because they lack the information they need to fully evaluate market conditions.

Eqira’s Solution

To combat this problem we have launched the Eqira Factor-Based Projections. Built upon our proprietary Market Factors, the Eqira Factor-Based Projections incorporate advanced statistical and machine learning techniques to provide daily performance estimates for otherwise unquoted assets and portfolios.

By modeling the performance of an asset relative to observable market factors, we can derive estimates for even the most illiquid assets at high frequencies. We currently provide daily indications for our primary hedge fund index, the Eqira Hedge Fund Composite Index, as well as 29 hedge fund other hedge fund strategies. We encourage any non-clients to request access to evaluate our projections, as well as our other products and services.

Eqira’s Factor-Based Projections Substantially Outperform Alternative Measures

Previously, investors have not had many reliable resources to evaluate hedge fund performance intra-month. HFR and Credit Suisse, two of the most widely followed providers of monthly non-investable benchmark hedge fund indexes, do both offer investable indexes that report performance intra-month. However these indexes suffer from the same basic problem: they only track a small subset of the available fund universe. As a result, they are heavily biased and typically exhibit considerable tracking error relative to their non-investable counterparts. The reporting and liquidity burden for funds participating in investable indexes is high and, as such, the best and most successful funds tend not to participate, resulting in indexes with meaningfully different returns than the traditional non-investable indexes. A 2011 Financial Times article noted that “The flagship investable HFRX Global Hedge Fund Index, for example, has undershot the non-investable HFRI Fund Weighted Composite Index every year since 2003, by an average of 560 basis points.”

A 560 basis point annual underperformance is simply too large to call reliable. Eqira’s Factor-Based Projections tend to be about twice as accurate, reducing prediction error by roughly 50%. Most of our models have produced r-squareds of at least 85%, meaning that their predictions explain over 85% of the variance in actual returns. Many exceed 90%, with long-term tracking errors often ranging from 25 to 50 basis points. We should note that our results are free from look-ahead bias: we generated our historical forecasts using only information available at the time of the forecast and evaluated performance entirely out-of-sample.

Beyond Index Estimation

A major advantage of our factor-based projection process is that we can apply it to any financial asset, even one without a daily investable index. We can tailor our process to individual hedge funds, different asset classes, and even client portfolios. If you have a security or portfolio that you would like to be able to track intra-month, please contact us to discuss how we can help.

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