Chapter 29 - An Empirical Analysis of Short-Biased Hedge Funds’ Risk-Adjusted Performance: A Panel Approach

Abstract

This chapter presents a study to investigate the risk-adjusted performance of hedge funds that follow a short-biased strategy. Short-biased hedge funds play an important role in spotting firms under duress while providing liquidity and price discovery to financial markets in order to prevent market bubbles. Even with the ban, during the credit crunch of 2008 and 2009, short-biased hedge funds as a group did very well. Given their strategies, short sellers will be inclined to perform well in bear markets and poorly in bull markets. This study uses rollover regressions to obtain and document that the risk-adjusted performance of short-biased hedge funds and their respective volatilities vary over time. It uses a panel approach to investigate the causes of short biased funds' change in performance overtime. An extensive set of control variables is proposed that includes both macro and market-based indices, but also fund-specific factors. The set of independent variables was constructed similarly to dependent variables using moving averages of 4 years' worth of monthly observations. Results of panel regressions suggest that market-based factors mainly affect Fung–Hsieh alphas, whereas fund-specific factors mainly influence the volatility of abnormal returns. It found that higher interest and inflation rates affect short-biased funds' performance negatively. Further, evidence suggests that risk-adjusted returns vary negatively with broader market indices, such as NYSE and NASDAQ, but positively with smaller market indices, such as the S&P 500. In addition, individual short-biased funds' Fung–Hsieh alphas are influenced negatively by the increased competition reflected by the higher returns of hedge fund indices.