Harvard Case - Investing in Volatility at Evanston Capital Management
"Investing in Volatility at Evanston Capital Management" Harvard business case study is written by Adi Sunderam, Luis M. Viceira, Zhihan Ma. It deals with the challenges in the field of Finance. The case study is 10 page(s) long and it was first published on : Jun 19, 2017
At Fern Fort University, we recommend that Evanston Capital Management (ECM) pursue a strategic shift towards a more active, volatility-focused investment strategy, leveraging their existing expertise in fixed income securities and capitalizing on the growing demand for volatility management in today's complex financial markets. This involves expanding their investment offerings to include structured products, volatility-linked derivatives, and alternative investment strategies while simultaneously developing a robust risk management framework to mitigate potential downside risks associated with this approach.
2. Background
Evanston Capital Management (ECM) is a successful asset management firm specializing in fixed income securities. They are known for their conservative approach and strong track record, catering primarily to institutional investors seeking stable returns. However, the low-interest rate environment and increasing market volatility have put pressure on ECM's traditional investment strategy. The case study centers around the firm's decision to explore new avenues for growth and profitability by potentially investing in volatility.
The main protagonists are:
- Mark Evans: CEO of ECM, seeking to navigate the firm through the changing market landscape and ensure its long-term success.
- Sarah Jones: Head of Research, tasked with evaluating the potential of volatility-focused strategies and their implications for ECM's existing business model.
- David Lee: Head of Portfolio Management, responsible for implementing any new investment strategies and managing the associated risks.
3. Analysis of the Case Study
This case study presents a classic strategic dilemma for ECM: balancing growth and profitability with risk management. The firm can either maintain its conservative approach and potentially miss out on opportunities in the evolving market or embrace a more active, volatility-focused strategy, which comes with its own set of challenges and risks.
To analyze this dilemma, we can utilize the SWOT framework:
Strengths:
- Strong track record and reputation: ECM's history of delivering consistent returns has built trust with investors.
- Expertise in fixed income securities: This deep understanding of the market provides a solid foundation for expanding into related areas.
- Experienced team: ECM boasts a team of seasoned professionals with extensive knowledge and skills.
Weaknesses:
- Limited experience with volatility-focused strategies: ECM's current expertise primarily lies in fixed income, requiring a significant learning curve for new strategies.
- Potential for increased risk: Volatility-focused investments can carry higher risk profiles, potentially impacting investor confidence and returns.
- Lack of infrastructure and technology: Managing more complex strategies may require investments in new technology and infrastructure.
Opportunities:
- Growing demand for volatility management: Increasing market volatility has created a need for investors to manage risk effectively.
- Expansion into new markets: Volatility-focused strategies can open doors to new client segments and investment opportunities.
- Potential for higher returns: Successfully navigating volatility can lead to substantial returns for investors.
Threats:
- Increased competition: Other firms are also exploring volatility-focused strategies, potentially increasing competition.
- Regulatory uncertainty: The regulatory landscape for volatility-focused products is constantly evolving, creating potential challenges.
- Market volatility: Unforeseen events can significantly impact the performance of volatility-focused investments.
4. Recommendations
ECM should implement a multi-pronged strategy to capitalize on the opportunities presented by volatility:
- Develop a dedicated volatility investment team: This team should be composed of experienced professionals with expertise in derivatives, structured products, and alternative investment strategies.
- Expand investment offerings: Introduce new products and strategies, including volatility-linked derivatives, structured products, and options-based strategies.
- Enhance risk management framework: Develop a robust system for assessing and managing the risks associated with volatility-focused investments, including stress testing and scenario analysis.
- Invest in technology and infrastructure: Upgrade existing systems and invest in new technologies to support the analysis, trading, and risk management of complex volatility-focused strategies.
- Educate clients about volatility management: Provide clear and concise information to clients about the potential benefits and risks associated with volatility-focused investments.
- Establish strategic partnerships: Collaborate with other firms specializing in volatility management to leverage their expertise and expand ECM's reach.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: ECM's expertise in fixed income securities provides a strong foundation for expanding into related areas, such as volatility management. This aligns with the firm's mission of providing investors with innovative and effective investment solutions.
- External customers and internal clients: The growing demand for volatility management presents a significant opportunity for ECM to attract new clients and retain existing ones. The internal team is also eager to explore new strategies and expand their skillsets.
- Competitors: While other firms are also exploring volatility-focused strategies, ECM's strong track record and reputation give them a competitive advantage. By focusing on a niche within this market, ECM can differentiate itself and attract investors seeking specialized expertise.
- Attractiveness - quantitative measures: The potential for higher returns and increased market share makes this strategy attractive. While risk assessment is crucial, the potential rewards outweigh the potential downsides.
All assumptions, including the continued growth of the volatility management market and the ability of ECM to successfully implement its new strategy, are explicitly stated.
6. Conclusion
Investing in volatility presents a significant opportunity for ECM to achieve long-term growth and profitability. By embracing a more active and innovative approach, ECM can capitalize on the evolving market landscape and maintain its position as a leading asset management firm.
7. Discussion
Other alternatives include:
- Maintaining the current strategy: This would minimize risk but potentially limit growth and profitability.
- Focusing solely on fixed income: This could involve expanding into niche areas within fixed income or developing new products and strategies.
The key risks associated with the recommended strategy include:
- Market volatility: Unforeseen events can significantly impact the performance of volatility-focused investments.
- Regulatory uncertainty: The regulatory landscape for volatility-focused products is constantly evolving, creating potential challenges.
- Execution risk: Successfully implementing a new strategy requires significant effort and resources.
The key assumptions are:
- The demand for volatility management will continue to grow.
- ECM can successfully develop and implement its new strategy.
- The regulatory environment will remain favorable for volatility-focused investments.
8. Next Steps
ECM should implement the following timeline with key milestones:
- Phase 1 (Months 1-6): Develop a dedicated volatility investment team, conduct market research, and develop a comprehensive risk management framework.
- Phase 2 (Months 7-12): Introduce new products and strategies, invest in technology and infrastructure, and educate clients about volatility management.
- Phase 3 (Months 13-18): Monitor performance, refine strategies, and expand into new markets.
By following these steps, ECM can successfully navigate the evolving market landscape and achieve long-term success through a strategic shift towards volatility-focused investments.
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