Relative importance of hedge fund characteristics

This study compares the relative importance of thirteen attributes in explaining the cross-sectional variations in the returns of hedge funds, using a large sample from the TASS database covering the 1989–2005 period. We use a simple characteristic-based model of return decomposition, which has never before been applied to hedge funds. The characteristic factors are estimated using cross-sectional dummy-variable regressions. Their importance is found to be time-varying. We find that diversification across styles matters, but that it could be improved significantly by also diversifying across other characteristics, mainly including performance, volatility and fee structure.      

The dynamics of hedge fund share restrictions

Nearly one in five hedge funds change their share restrictions (e.g., lockup) from 2007 to 2012. Using a large panel dataset, this paper is the first to empirically examine the incidence, determinants, and consequences of share restriction changes. We find that funds with high asset liquidity and low liquidity risk are more likely to decrease share restrictions and funds with good performance are more likely to increase share restrictions. A hazard model indicates that funds who actively manage liquidity concerns live longer by adjusting share restrictions. We examine whether changes in share restrictions create an endogeneity bias in the share illiquidity premium (Aragon, 2007) and find that 18% of the premium can be explained by the dynamic nature of contract changes.     

Timing is money: The factor timing ability of hedge fund managers

This paper studies the level, determinants, and implications of the factor timing ability of hedge fund managers. We find that approximately 34% of hedge funds display factor timing ability on at least one factor over the full sample, concentrated especially at the market, size, and bond factors. Better factor timing skills are on average related to funds that are more experienced and more flexible, but the cross-factor heterogeneity is considerable. Factor timing is associated with outperformance; the top factor timing funds outperform the bottom factor timing funds with a significant 4.32% per annum. Timing skills, though, do not directly lead to higher net flow.     

Optimal hedge fund portfolios under liquidation risk

We use an expected utility framework to integrate the liquidation risk of hedge funds into portfolio allocation problems. The introduction of realistic investment constraints complicates the determination of the optimal solution, which is solved using a genetic algorithm that mimics the mechanism of natural evolution. We analyse the impact of the liquidation risk, of the investment constraints and of the agent's degree of risk aversion on the optimal allocation and on the optimal certainty equivalent of hedge fund portfolios. We observe, in particular, that the portfolio weights and their performance are significantly affected by liquidation risk. Finally, tight portfolio constraints can only provide limited protection against liquidation risk. This approach is of special interest to fund of hedge fund managers who wish to include the hedge fund liquidation risk in their portfolio optimization scheme.     

The role of derivatives in hedge fund activism

Using a hand-collected sample of hedge fund activist engagements from 1994 to 2014, this study analysed the role of derivatives in the hedge fund activism. Evidence shows abnormal returns of targets of hedge fund activists who did not use derivatives exceeded the abnormal returns of targets of hedge fund activists who employed derivatives around the activist engagement disclosure period. We also find that idiosyncratic volatility of the targets of hedge fund activists who did not use derivatives was more reduced than that of the targets of hedge fund activists who used derivatives. Finally, the probability of takeovers increases for hedge fund activists who did not use derivatives.     

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.     

The influence of buy-side analysts on mutual fund trading

We present evidence on the trading and performance impact of buy-side analysts. Using data provided by a large global asset manager, we relate buy-side analysts’ recommendations to fund transactions on a daily basis. We show that buy-side analysts significantly influence trading decisions: Fund managers strongly follow recent recommendation revisions, even after controlling for other trading determinants. Positive abnormal returns to buy-side analysts’ revisions are also reflected in the performance of mutual fund trades: Trades triggered by buy-side recommendations have higher returns than other trades. Overall, the impact of buy-side analysts is more pronounced than that of sell-side analysts.     

Investment behavior of mutual fund shareholders: The evidence from aggregate fund flows

The relationship of stock market returns with components of aggregate equity mutual fund flows (new sales, redemptions, exchanges-in, and exchanges-out) is examined. Vector autoregressions and tests of linear feedback show that the flow-return relationship exists solely between returns and exchanges-in and -out. Further, only exchanges-out are responsible for the contrarian flow behavior noted by Warther (1995). The evidence suggests that the various components reflect different investor objectives and information.     

Trades of the living dead: Style differences, style persistence and performance of currency fund managers

We make use of a new database on daily currency fund manager returns over a three-year period, 2005–2008. This higher frequency data allows us to estimate both alpha measures of performance and beta style factors on a yearly basis, which in turn allows us to test for persistence. We find no evidence to support alpha persistence; a manager’s alpha in one year is not significantly related to his alpha in the prior year. On the other hand, there is substantial evidence for style persistence; funds that rely on carry, trend or value trading or with a long/short bias toward currency volatility are likely to maintain that style in the following year. In addition, we are able to examine the performance of managers that survive through the entire sample period, versus those that drop out. We find significant differences in both the investment styles of living versus deceased funds, as well as their realized alpha performance measures. We conjecture that both style differences and ineffective market timing, rather than market conditions, have impacted performance outcomes and induced some managers to close their funds.     

External monitoring and returns to hedge fund activist campaigns

Firms targeted by hedge fund activists experience significantly higher returns when there are fewer external monitors in place at the target firm. Using analyst coverage and institutional ownership as measures of external monitoring presence, we find that low‐monitored activist targets experience abnormal returns 17.52% above that of high‐monitored targets in the 2‐year period following the initial campaign start date. The significant effect of external monitoring remains after controlling for target firm and activist characteristics. We also document improved operating performance and an increased monitoring presence at low‐monitored target firms across the same 2‐year period, consistent with the observed market performance.     

Highwaymen or heroes: Should hedge funds be regulated?: A survey

There are increasing calls for the regulation of hedge funds, both for consumer protection and systemic reasons. We argue that the consumer protection arguments for direct regulation are not convincing, but find that the systemic concerns are sufficiently serious to warrant some forms of regulation. Existing regulatory methods, disclosure and activity restrictions, are unsuitable for hedge funds. Any future regulation must reduce the likelihood and potential costs of the failure of systemically important hedge funds while at the same time preserving the wider market benefits of hedge funds’ ongoing activities.     

Performance measurement of hedge funds using data envelopment analysis

Data envelopment analysis (DEA) is a nonparametric method from the area of operations research that measures the relationship of produced outputs to assigned inputs and determines an efficiency score. This efficiency score can be interpreted as a performance measure in investment analysis. Recent literature contains intensive discussion of using DEA to measure the performance of hedge funds, as this approach yields some advantages compared to classic performance measures. This paper extends the current discussion in three aspects. First, we present different DEA models and analyze their suitability for hedge fund performance measurement. Second, we systematize possible inputs and outputs for DEA and again examine their suitability for hedge fund performance measurement. Third, two rules are developed to select inputs and outputs in DEA of hedge funds. Using this framework, we find a completely new ranking of hedge funds compared to classic performance measures and compared to previously proposed DEA applications. Thus, we propose that classic performance measures should be supplemented with DEA based on the suggested rules to fully capture hedge fund risk and return characteristics.      

Information spillovers and performance persistence for hedge funds

We present a simple model that rationalizes performance persistence in hedge fund limited partnerships. In contrast to the model for mutual funds of Berk and Green (2004), the learning in our model pertains to profitability associated with an innovative trading strategy or emerging sector, rather than ability specific to the fund manager. As a result of potential information spillovers, which would increase competition if informed investors were to partner with non-incumbent managers, incumbent managers will let informed investors benefit from increases in estimated profitability following high returns realized with the trading strategy or in the sector.     

全球流动性过剩、对冲基金发展与中国金融稳定

全球流动性过剩导致全球金融资产激增,推动对冲基金业规模迅速膨胀,也使得对冲基金业在结构和投资动向上也出现了新的变化。对冲基金在全球寻找套利和投机机会,对全球的金融稳定产生一定的影响,在此背景下,中国需要审慎资本项目开放和加强对冲基金的监管。     

A fully parametric approach to return modelling and risk management of hedge funds

This paper examines the empirical properties of hedge fund returns and proposes a fully parametric model capable of adequately describing both univariate and multivariate return properties. The suggested model is based on the multivariate extension of the Normal Inverse Gaussian (NIG) distribution and will be shown to be capable of capturing the characteristic distributional features of hedge fund returns. Drawing on recent research in the area of Generalized Hyperbolic distributions and their calibration, we will elaborate on the application of the NIG-model for risk management purposes, and highlight the differences between the NIG and the Gaussian model.      

Structural holes and hedge fund return comovement: evidence from network-connected stock hedge funds in China

Using data from a new hedge fund database, we examine the impact of social networks on the return comovement of stock hedge funds in China. We use structural holes in the college alumni networks of managers to measure the managers’ social network positions. We perform an empirical analysis on a sample of 3,012 hedge fund products in China from 2010 to 2017. We find that greater structural holes are associated with higher return comovement. The positive impact of the structural holes on return comovement is not affected by market cycles, a manager's major in college, or his or her abilities.     

Predicting hedge fund performance when fund returns are skewed

We show that fund-specific return skewness is associated with managerial skill and future hedge fund performance. Specifically, skewness in fund returns reflects managerial skill in avoiding large drawdowns. Using a new measure of investment skill that accounts for this managerial ability, we demonstrate that traditional performance measures underestimate (overestimate) managerial performance when returns exhibit positive (negative) fund-specific skewness. Our new measure is particularly valuable during periods of economic crisis, when the annual risk-adjusted outperformance is 5.5%.     

Purchase and redemption decisions of mutual fund investors and the role of fund families

This paper investigates the purchases and redemptions of a large cross-sectional sample of German equity funds. We find that investors not only punish bad performance by selling their shares, but also have a tendency to sell winners. Investors in large fund families show higher sales and redemption rates. Furthermore, family size also affects the flow-performance relationship: investors in large families punish bad performance more. Last, we find that inner family rankings play an important part for redemptions, with investors strongly redeeming their shares from intra-family losers. This result provides a potential reconciliation to the apparent contradiction between the low average holding period of mutual fund investors and the lack of investor discipline.     

Dynamic prediction of hedge fund survival in crisis-prone financial markets

This study focuses on dynamic changes in survival probabilities over the lifetimes of hedge funds. To model such probabilities, a mixed Cox proportional hazards (CPH) model-specifically, a survival/hazard model with time-varying covariates and fixed covariates- is employed. Resulting dynamic survival probabilities show that the mixed CPH model provides significantly higher accuracy in predicting hedge fund failure than other models in the literature, including fixed covariate CPH models and discrete logit models. Our results are useful to investors and regulators of hedge funds in crisis-prone financial markets.