Understanding Alternative Investing Through Asymmetric Payoffs

Investing in alternative investment vehicles are typically attractive to investors due to their lower correlation with traditional asset classes like stocks and bonds. The idea is that the ability of alternative vehicles to invest in non-traditional asset classes can help protect investment portfolios against sharp downturns while also participating in positive markets. The purported goal is to change the relation of the portfolio to the equity market from a linear, symmetric profile (up when markets are up, down when markets are down) to a more asymmetric profile.

Given that, it would be valuable to discern the relationship between returns from alternative vehicles, such as hedge funds, and equity markets. Instead of simply looking at traditional performance metrics (returns, volatility, Sharpe ratios, drawdowns, etc) we use a different lens to understand the performance of alternatives and try to answer two questions:

  1. Do alternatives in fact provide asymmetric payoffs, and if so
  2. Is the relationship convex (up when equity markets are up and flat when equity markets are down) or concave (flat when equity markets are up and down when equity markets are up)?

Iris has the answers.