Can investors benefit from the performance of alternative UCITS funds?

We study the performance persistence of alternative UCITS funds, which are a hybrid between mutual funds and hedge funds. Persistence is gauged by alternative measures of performance and risk. Based on contingency tables, we find that performance persists for up to 2 years following ranking. However, persistence is stronger in the short run, and ranked portfolio tests indicate that investors can benefit from persistence for only up to 1 year. The evidence for persistence in risk is ambiguous. We link fund characteristics to performance persistence and find that offshore hedge fund experience enhances persistence. Our results are robust against survivorship bias and other potential database biases.     

The fragile capital structure of hedge funds and the limits to arbitrage

During a financial crisis, when investors are most in need of liquidity and accurate prices, hedge funds cut their arbitrage positions and hoard cash. The paper explains this phenomenon. We argue that the fragile nature of the capital structure of hedge funds, combined with low market liquidity, creates a risk of coordination in redemptions among hedge fund investors that severely limits hedge funds' arbitrage capabilities. We present a model of hedge funds' optimal asset allocation in the presence of coordination risk among investors. We show that hedge fund managers behave conservatively and even abstain from participating in the market once coordination risk is factored into their investment decisions. The model suggests a new source of limits to arbitrage.     

The alpha and omega of fund of hedge fund added value

In spite of a somewhat disappointing performance throughout the crisis, investors are showing interest in hedge funds. Still, funds of hedge funds keep on experiencing outflows. Can this phenomenon be explained by the failure of fund of hedge fund managers to deliver on their promise to add value through active management, or is it symptomatic of a move toward greater disintermediation in the hedge fund industry? We introduce a return-based attribution model allowing for a full decomposition of fund of hedge fund performance. The results of our empirical study suggest that funds of hedge funds are funds of funds like others. Strategic allocation turns out to be a crucial step in the investment process, in that it not only adds value over the long-term, but most importantly, it brings resilience precisely when investors need it the most. Fund picking, on the other hand, turns out to be a double-edged sword.     

Hedge funds and financial stability: Regulating prime brokers will mitigate systemic risks

We review key characteristics of the hedge fund industry, and identify conditions under which this sector can pose a threat to financial stability. Direct regulation of hedge funds that increases transparency does not appear feasible, may create a moral-hazard problem, and may reduce market liquidity. Indirect regulation by prime brokers and market discipline by creditors, counterparties, and investors have been effective in limiting the risks from the hedge fund sector. To reduce systemic risks, more regulation of prime brokers is warranted to avoid competitive dynamics from undermining counterparty risk management practices.     

基金业绩归因与投资者行为

本文以2006年1月至2016年12月中国64家股票型主动管理基金为样本,从基金净资金流变化的角度,检验了投资者决策与基金业绩结构的关系,以期更好地理解投资者行为。本文结论有:(1)整体上,投资者在衡量基金经理能力时,更关注原始超额收益率或只基于市场风险调整风险敞口,这可能与中国市场投资工具仍然不够充分、风险难以有效对冲有关;(2)机构投资者相比个人投资者对风险敞口的识别更严格;(3)简单模型的优势集中在市场波动低、投资者情绪高的时期;(4)除基金经理能力外,净资金流变化对市场风险报酬也很敏感;(5)从alpha的角度,我国基金市场仍存在“赎回异象”,可能与“处置效应”有关,仍需提升投资者对风险的认知,引导市场形成更加科学的投资观念。     

The wisdom of crowds: Mutual fund investors’ aggregate asset allocation decisions

We find that the aggregate asset allocation decisions of US mutual fund investors depend on economic conditions. Both anticipated economic downturns and periods of turmoil lead investors to direct flow away from risky equity funds and towards lower-risk money market funds. These patterns are markedly stronger for investors in low cost and low turnover funds relative to investors in high cost and high turnover funds, consistent with sophisticated investors being more sensitive to changing conditions. Benchmarked against a buy-and-hold strategy, these asset allocation strategies reduce risk without degrading the risk-return trade-off. Our evidence suggests that individual investors, often dismissed as noise traders, collectively react to economic signals in a sensible manner when determining asset allocations.     

Style chasing by hedge fund investors

This paper examines whether investors chase hedge fund investment styles. We find that better-performing and more popular styles are rewarded with higher inflows in subsequent periods. This indicates that investors compare hedge fund styles in terms of recent performance and popularity, and they subsequently reallocate funds from less successful to more successful styles. Furthermore, we find evidence of competition between individual hedge funds of the same style. Funds outperforming the other funds in their styles and funds whose inflows exceed the average flows in their styles experience higher inflows in subsequent periods. One of the reasons for competition among same-style funds is investors’ search for the best managers. The high minimum investment required to invest in a hedge fund limits investors’ diversification opportunities and makes this search particularly important. Finally, we show that hedge fund investors’ implementation of style chasing in combination with intra-style fund selection represents a smart strategy.     

Higher risk,lower returns: What hedge fund investors really earn

The returns of hedge fund investors depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows in and out of these funds. We use dollar-weighted returns (a form of Internal Rate of Return (IRR)) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our main finding is that annualized dollar-weighted returns are on the magnitude of 3% to 7% lower than corresponding buy-and-hold fund returns. Using factor models of risk and the estimated dollar-weighted performance gap, we find that the real alpha of hedge fund investors is close to zero. In absolute terms, dollar-weighted returns are reliably lower than the return on the Standard & Poor's (S&P) 500 index, and are only marginally higher than the risk-free rate as of the end of 2008. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.     

Activist hedge funds and firm disclosure

This study examines whether firms' disclosure decisions are affected by the presence of activist hedge funds. Using a large sample of firms that experienced increases in ownership by activist hedge funds, we find that firms are more likely to cease providing financial guidance or reduce the information in the guidance in the quarter subsequent to new investment by activist hedge funds. These results hold even for firms that experienced good quarters and consistently provided guidance in previous quarters. Since guidance has been shown to be beneficial to capital market participants in many ways, reduced guidance has meaningful market implications. Our findings highlight a negative and possible unintended consequence of activist hedge funds' investment in firms, which provides some counterbalance to the numerous positive consequences documented in the prior literature on hedge fund activism.     

Hedge Funds and Corporate Innovation

Using National Bureau of Economics Research patent data and hedge fund holdings in US firms from 1998 to 2006, we examine the effect of hedge fund ownership on corporate innovation. We find that hedge fund ownership increases both patent quantity and quality, even after controlling for endogeneity. Hedge funds appear to increase innovation and firm value by increasing research and development (R&D) productivity and innovation efficiency rather than R&D input. Our study suggests another channel through which hedge funds may enhance firm value, contributing to the literature on hedge fund ownership.     

Capacity constraints,investor information,and hedge fund returns

To identify capacity constraints in hedge funds and simultaneously gauge how well-informed hedge fund investors are, we need measures of investor demand that do not affect deployed hedge fund assets. Using new data on investor interest from a secondary market for hedge funds, this paper verifies the existence of capacity constraints in hedge funds. There is more mixed evidence on the information available to hedge fund investors. Buy and sell indications arrive following fund outperformance. While buy indications have little incremental power to predict hedge fund performance over and above well-known forecasting variables, sell indications do somewhat better.     

Hedge fund seeding with fees-for-guarantee swaps

This paper introduces a new instrument in the context of hedge fund seeding, which we call fees-for-guarantee swap, with the aim of alleviating the early-stage funds (ESF) managers' financial constraint caused by severe asymmetric information between investors and managers. The swap plays a role in enhancing the ESFs manager's credibility by swapping part of her fees for an insurance on the behalf of seeding investors, whom would be fully refunded once the fund defaults. We set up a dynamic continuous-time framework within which closed-form prices for seed capital, guarantee costs and other claims have been derived. Our numerical findings indicate that incentive compensations, managerial ownership and hedge funds liquidation risks not only inhibit ESFs managers' risk-shifting incentive but align interests among ESFs manager, seeder and insurer as well.     

THE GROWTH OF INSTITUTIONAL STOCK OWNERSHIP: A PROMISE UNFULFILLED

Despite the substantial growth of institutional ownership of U.S. corporations in the past 20 years, there is little evidence that institutional investors have acquired the kind of concentrated ownership positions required to be able to play a dominant role in the corporate governance process. Institutional ownership remains widely dispersed among firms and institutions in large part because of significant legal obstacles that discourage institutional investors both from taking large block positions and from exercising large ownership positions to control corporate managers. Thus, although much of the growth of institutional ownership since 1980 has been accounted for by the growth of mutual funds and private pension funds, there continue to be strong deterrents to the accumulation and use of large ownership positions to influence corporate managers. Another potentially important factor discouraging concentrated investments are incentive schemes that effectively reward money managers for producing returns that do not vary much from the S&P 500 (or whatever sector the manager is supposed to be representing). Using a very different incentive scheme that offers managers a share of the excess returns (as well as penalties for failure to meet benchmarks), a relatively new class of “hedge funds” has emerged that provides both more concentrated ownership positions and higher risk‐adjusted rates of return. To encourage mutual funds to take a more activist corporate governance role and to behave more like hedge funds, the authors recommend that current legal restrictions on mutual funds be relaxed so that mutual funds have a greater incentive to hold large ownership positions in companies and to use those positions to more effectively monitor corporate managers. In particular, the “five and ten” portfolio rules applicable to mutual funds could be repealed and replaced with a standard of prudence and diligence more in keeping with portfolio theory; mutual funds could be given greater freedom to adopt redemption policies that would be more conducive to holding larger ownership positions; and institutional investors could be permitted to employ a variety of incentive fee structures to encourage fund managers to pursue more pro‐active investment strategies. The prospect of actively involving institutional fund managers in the corporate governance process may be our best hope for improving U.S. corporate governance.     

Duration of poor performance and risk shifting by hedge fund managers

A typical hedge fund manager receives greater compensation after strong performance but does not lose compensation after weak performance, and therefore might take on more risk for the second half of the year after poor returns in the first half. We refer to this as “risk shifting.” However, continual risk shifting over a long period would likely make the fund too volatile to attract investors. We find that hedge funds with poor first-half-year performance do tend to increase risk during the second half-year. The effect is larger for funds that began the year “under water” and for smaller funds. The effect is smaller, however, if the poor performance lasts long.     

Stochastic dominance analysis of Asian hedge funds

We employ the stochastic dominance approach that utilizes the entire return distribution to rank the performance of Asian hedge funds as traditional mean-variance and CAPM approaches could be inappropriate given the nature of non-normal returns. We find both first-order and higher-order stochastic dominance relationships amongst the funds and conclude that investors would be better off by investing in the first-order dominant funds to maximize their expected wealth. By investing in higher-order dominant funds, risk-averse investors can maximize their expected utilities but not their wealth. In addition, we find the common characteristic for most pairs of funds is that one fund is preferred to another in the negative domain whereas the preference reverses in the positive domain. We conclude that the stochastic dominance approach is more appropriate compared with traditional approaches as a filter in hedge fund selection. Compared with traditional approaches, the SD approach, not only is assumption free, but also provides greater insights to the performance and risk inherent in a hedge fund's track record.     

The liquidity risk of liquid hedge funds

This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79% per year after adjusting for risk. The return impact of fund flows is stronger when funds embrace liquidity risk, when market liquidity is low, and when funding liquidity, as measured by the Treasury-Eurodollar spread, aggregate hedge fund flows, and prime broker stock returns, is tight. In keeping with an agency explanation, funds with strong incentives to raise capital, low manager option deltas, and no manager capital co-invested are more likely to take on excessive liquidity risk. These results resonate with the theory of funding liquidity by Brunnermeier and Pedersen (2009).     

Commonality in hedge fund returns: Driving factors and implications

We measure the commonality in hedge fund returns, identify its main driving factor and analyze its implications for financial stability. We find that hedge funds’ commonality increased significantly from 2003 until 2006. We attribute this rise mainly to the increase in hedge funds’ exposure to emerging market equities, which we identify as a common factor in hedge fund returns over this period. Our results show that funds with a high commonality were affected disproportionately by illiquidity and exhibited negative returns during the subsequent financial crisis, thereby providing little diversification benefits to the financial system and to investors.     

Corporate governance and hedge fund activism

Recently, the mainstream media have paid considerable attention to hedge funds behaving as agents of corporate change. We study this phenomenon using a unique dataset of hedge fund activism for the period 1994–2005, and find evidence that hedge fund activists improve both short-term stock performance and long-term operating performance of their targets. The most dramatic changes in performance accrue to targets where activists seek corporate governance changes and reductions in excess cash. Additionally, hedge funds themselves benefit from activism: the risk-adjusted annual performance of hedge funds seeking changes in corporate governance is about 7–11% higher than for non-activist hedge funds and hedge funds pursuing less aggressive activism. These results imply that hedge funds can facilitate long-lasting changes in corporate governance, cash flows, and operating performance that benefit target firm shareholders and hedge fund investors alike.     

Hedge funds and optimal asset allocation: Bayesian expectations and spanning tests

This paper analyzes the contribution of hedge funds to optimal asset allocations between 1993 and 2010. The preferences of specific institutional investors are captured by implementing a Bayesian asset allocation framework that incorporates heterogeneous expectations regarding hedge fund alpha. Mean-variance spanning tests are used to infer the ability of hedge funds to significantly enhance the mean-variance efficient frontier. Further, a novel democratic variance decomposition procedure sheds light on the dynamics in the co-movement of hedge fund returns with a set of common benchmark assets. The empirical findings indicate that portfolio benefits of hedge funds are time-varying and strongly depend on investor optimism regarding hedge funds’ ability to generate alpha. In general, allocations to hedge funds improve the global minimum variance portfolio even after controlling for short-selling restrictions and minimum diversification constraints. However, due to dynamics underlying the composition of the aggregate hedge fund universe, the factor structure of hedge fund returns has become more similar to the benchmark assets over time.     

Alpha or beta in the eye of the beholder: What drives hedge fund flows?

Capital Asset Pricing Model (CAPM) alpha explains hedge fund flows better than alphas from more sophisticated models. This suggests that investors pool together sophisticated model alpha with returns from exposures to traditional (except for the market) and exotic risks. We decompose performance into traditional and exotic risk components and find that while investors chase both components, they place greater relative emphasis on returns associated with exotic risk exposures that can only be obtained through hedge funds. However, we find little evidence of persistence in performance from traditional or exotic risks, which cautions against investors’ practice of seeking out risk exposures following periods of recent success.