Hedge fund liquidity and performance: Evidence from the financial crisis |
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Authors: | Nic Schaub Markus Schmid |
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Institution: | 1. University of Mannheim, Finance Area, D-68131 Mannheim, Germany;2. Swiss Institute of Banking and Finance, University of St. Gallen, CH-9000 St. Gallen, Switzerland |
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Abstract: | We investigate how share restrictions affect hedge fund performance in crisis and non-crisis periods. Consistent with prior research, we find that in the pre-crisis period more illiquid funds generate a share illiquidity premium compensating investors for limited liquidity. In the crisis period, this share illiquidity premium turns into an illiquidity discount. Hedge funds with more stringent share restrictions invest more heavily in illiquid assets. While share restrictions enable funds to manage illiquid assets effectively in the pre-crisis period, they seem insufficient to ensure effective management of illiquid portfolios in the crisis. In a crisis period, funds holding illiquid portfolios experience lower returns and alphas, also when share restrictions are controlled for. Funds with an asset–liability mismatch perform particularly poorly and experience the strongest outflows. Share restrictions are also a proxy for incentives as investors cannot immediately withdraw their money after poor performance. We show that higher incentive fees can offset the share illiquidity discount in the crisis period. |
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Keywords: | G01 G12 G23 |
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