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.     

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.     

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.     

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.     

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.      

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.     

Performance hypothesis testing with the Sharpe ratio: The case of hedge funds

As recent research highlights that the Sharpe ratio has a decision theoretic foundation even in the case of asymmetric or fat-tailed excess returns and thus is adequate even for the evaluation of hedge funds, this note provides the first Sharpe ratio based performance analysis of the hedge fund market. Furthermore, it addresses the important practical question whether the choice of hypothesis test used to statistically compare Sharpe ratios can influence an investor’s hedge fund selection process. Our key findings are as follows: (i) Only a small fraction of hedge funds in our large dataset can significantly outperform passive investments in corresponding hedge fund indices. (ii) Especially in the presence of autocorrelated or skewed excess returns, the traditional test of Jobson and Korkie, 1981, Memmel, 2003 tends to overstate the number of significant outperformers and thus provides potentially misleading information for investors. Decision makers are advised to use the bootstrap test of Ledoit and Wolf (2008) allowing robust and more reliable inference.     

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.     

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.     

Generalized runs tests to detect randomness in hedge funds returns

The major contribution of this paper is to make use of generalized runs tests (Cho and White, 2011) to analyze the randomness, i.e. the lack of persistence, in both absolute and relative returns of hedge funds. We find that about 42% of the HFR universe exhibit iid absolute returns over the period spanning 2000 to 2012. These funds are mainly found in proportions within the Macro and Equity Hedge strategies. A similar result holds for relative returns. We also find that funds having non-iid returns often exhibit ARCH effects and structural breaks, with largest breaks located within financial crises. Also, only a small percentage displays persistence in their relative performance, 8.2% to 16.7% of the universe, mainly found in proportions within the Relative Value and Event-Driven strategies. The robustness of results is challenged by implementing the tests on a crisis-free period. We find similar results for absolute returns. For relative ones, differences appear across strategies and benchmarks, but still both ARCH and breaks are present. Our work contributes to the hedge fund literature in terms of methodology, portfolio allocation, and performance measurement.     

Caught in the crossfire: How the threat of hedge fund activism affects creditors

Firms under the threat of hedge fund activism on average experience significant losses of outstanding bondholder wealth: their bond yields rise while prices fall and ratings deteriorate. Under-threat firms receive inferior terms when initiating new loans. These observations are more prominent in firms with weaker creditor rights protection and firms that experience more significant improvement in stock performance without accompanying real improvements. These findings are consistent with the manifestation of agency problems. Share repurchases funded by cash, investment cutbacks, and new debt issuances elevate share price, which increases the cost of intervention for activists but jeopardizes the interest of existing bondholders.