Equity Hedge Funds Research Articles

Fundamental Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

Abstract We exploit detailed transaction and position data for a sample of long-short equity hedge funds to study the trading activity of fundamental investors. We find that hedge funds exhibit skill in opening positions, but that they close their positions too early, thereby forgoing about one-third of the trades’ potential profitability. We explain this behavior with the limits of arbitrage: hedge funds close positions early in order to reallocate their capital to more profitable investments and/or to accommodate tightened financial constraints. Consistent with this view, we document that hedge funds leave more money on the table after opening new positions, negative returns, or increases in funding constraints and volatility. (JEL G11, G12, G14, G15)

Fundamental Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

<ns2:p>We exploit detailed transaction and position data for a sample of long-short equity hedge funds to study the trading activity of fundamental investors. We find that hedge funds exhibit skill in opening positions, but that they close their positions too early, thereby forgoing about a third of the trades' potential profitability. We explain this behavior with the limits of arbitrage: hedge funds close positions early in order to reallocate their capital to more profitable investments and/or to accommodate tightened financial constraints. Consistent with this view, we document that hedge funds leave more money on the table after opening new positions, negative returns, or increases in funding constraints and volatility.</ns2:p>

Hedge Fund Alpha: Cycle or Sunset?

The hedge fund industry has grown from $200 billion in assets under management around the turn of the millennium to now over $3 trillion. Many reports have criticized hedge funds for poor performance, particularly since the 2008 Global Financial Crisis (GFC). In this article, the author seeks to demystify hedge fund strategies by evaluating fund performance that can be attributed to the markets as well as other well-known systematic factors with an emphasis on outcomes prior to and following the 2008 GFC. When adjusted for risk to stock/bond markets, the evidence shows that, after fees and costs, hedge fund managers as a group have shown a marked decline in risk-adjusted alpha in the 10 years following the GFC. To aid in a better understanding of the alpha deterioration, he further investigates equity hedge fund returns against a suite of well-known systematic risk/return factors documented in the literature beyond traditional market factors. In all, the model explains nearly 90% of the variation in returns. Equity hedge funds as a group show meaningful and consistent exposures to many of these factors over time, but whether intended or otherwise, significant changes also occurred (including a significant decline in active risk) following the GFC, in turn influencing their performance. Armed with this information, investors are hopefully better positioned to make more-informed decisions in deciding hedge fund strategy allocations. <b>TOPICS:</b>Real assets/alternative investments/private equity, financial crises and financial market history, performance measurement <b>Key Findings</b> ▪ In the 10 years following the 2008 Global Financial Crisis (GFC), hedge funds overall (and a subset of equity-focused hedge fund managers) have witnessed a deterioration in alpha—declining 4.4% annually to −1.0% a year, on average, net of fees and costs. ▪ Results of a multi-factor model explaining up to 90% of excess return variation show that hedge funds have meaningfully altered how they drive performance, partially explaining the observed change in results post-GFC. ▪ Equity hedge fund managers significantly reduced their active risk in the post-GFC period versus the earlier period, which is likely another important contributor to the decline in alpha over the past decade.

A Performance Update—Hedge Funds versus Hedged Mutual Funds: An Examination of Equity Long–Short Funds

This article presents a performance update for the equity long–short mutual funds that were first described and analyzed in McCarthy (2014), extending that analysis to the period from July 2013–December 2019. The analyses confirm that the equity long–short mutual funds provide investment exposure similar to leading equity long–short hedge fund indexes. However, in this later time period, they underperformed the S&P 500 Index and traditional hedge fund indexes. In addition, none of the indexes (i.e., the Index of Equity Long–short Mutual Funds, the HFRI Equity Hedge Fund Index, the DJ-CS L/S Equity Hedge Fund Index, or the CISDM Equity Long–Short Index [as modified]) had positive risk-adjusted returns, as measured by alpha over this later period, and none of the 24 equity long–short mutual funds with full data for the period from July 2013–December 2019 had positive alpha. This article also presents data on the lack of performance persistence across the equity long–short mutual funds, analyzes the considerable change in asset sizes of some of these funds, reports on the closure rate of equity long–short mutual funds over this time period, and notes the positive relationship between excess performance over the S&P 500 Index and equity long–short mutual fund net asset flows. Finally, the appendix broadens the analysis to include equity long–short mutual funds started after July 2013. The performance results from this expanded universe of funds is materially the same as the original sample of mutual funds from 2013. TOPIC:Mutual fund performance Key Findings This article examines equity long-short mutual funds over the period from July 2013–December 2019. It extends an earlier analysis of these same mutual funds through June 2013 (McCarthy 2014) and finds the following: a) Equity long–short mutual funds continue to provide investment exposure similar to equity long–short hedge funds. b) Equity long–short mutual funds have substantially underperformed the S&P 500 Index in absolute return terms over the analysis period (3.4% p.a. vs. 13.7% for the S&P 500). Moreover, as a group, they generated negative alpha over this period (−4.0% p.a.). Further, no individual equity long–short mutual fund included in the analysis earned a positive alpha over this six-and-a-half-year period. c) Equity long–short mutual funds performed similarly to, although slightly behind, leading equity long-short indexes over the analysis period. d) Over the analysis period, no persistence in individual equity long–short mutual fund manager performance was identified. Additionally, as a group and individually, equity long–short mutual funds had difficulties maintaining their asset levels. Only one of the largest five funds in 2013 was still among the five largest at the end of 2019. The article also includes performance data for equity long–short mutual funds begun after June 2013. The results are largely indistinguishable from the funds begun before that date. That is, this expanded universe of funds also substantially underperformed the S&P 500 Index, as a group did not earn positive alpha, and underperformed leading hedge fund indexes.

Political Cognitive Biases Effects on Fund Managers’ Performance

Does political affiliation matter for stock-market investing? Rare events can produce polarized narratives that potentiate cognitive dissonance on a spectrum of agents. Using a comprehensive dataset of equity hedge funds’ performance and managers’ political affiliation matched by their partisan contributions, I document higher returns of funds managed by Democrats for ten subsequent months—from December 2008 to September 2009—when the interpretation of the US central bank policy was politically polarized and conducive to cognitive dissonance. This result is robust to a set of falsification tests and randomized quasi-experiments.

Hedge Fund Alpha: Cycle or Sunset?

The hedge fund industry has grown from $200 billion in assets under management around the turn of the millennium to now over $3 trillion. Many reports have criticized hedge funds for poor performance, particularly since the 2008 global financial crisis (GFC). In this paper, I seek to demystify hedge fund strategies by evaluating fund performance that can be attributed to the markets as well as other well-known systematic factors with an emphasis on outcomes prior to and following the 2008 GFC. When adjusted for risk to stock/bond markets, the evidence shows that, after fees and costs, hedge fund managers as a group have shown a marked decline in risk-adjusted alpha in the 10 years following the GFC. To aid in a better understanding of the alpha deterioration, I further investigate equity hedge fund returns against a suite of well-known systematic risk/return factors documented in the literature beyond traditional market factors. In all, the model explains nearly 90 percent of the variation in returns. Equity hedge funds as a group show meaningful and consistent exposures to many of these factors over time, but whether intended or otherwise, significant changes also occurred (including a significant decline in active risk) following the GFC, in turn influencing their performance. Armed with this information, investors are hopefully better positioned to make more informed decisions in deciding hedge fund strategy allocations.

Hedge Funds Versus Hedged Mutual Funds: An Examination of Long/Short Funds; A Performance Update

This paper updates the performance of those equity long/short mutual funds analyzed in “Hedge Funds Versus Hedged Mutual Funds: An Examination of Long/Short Funds” (The Journal of Alternative Investments, Winter 2014) (McCarthy, 2014). Section 1 of this paper focuses on the period July 2013 - December 2019, extending the analysis in McCarthy, 2014. This later period is characterized by an extended equity bull market. The analyses below find that these equity long/short mutual funds provide investment exposure similar to leading equity long/short hedge fund indexes. However, as a group, they underperformed the S&P 500 Index and traditional hedge fund indexes. It is further shown that none of the indexes considered in this paper (i.e. the Index of Equity Long/Short Mutual Funds, the HFRI Equity Hedge Fund Index, the DJ-CS L/S Equity Hedge Fund Index, or the CISDM Equity Long/Short Index) had positive risk adjusted returns over this later period. In addition, none of the 24 equity long/short mutual funds with full data for the period July 2013 - December 2019 had positive alpha. The paper also presents data on the lack of performance persistence across these mutual funds, analyzes the considerable change in assets of some of these funds, reports their closure rates, and notes the positive relationship between excess performance over the S&P 500 and net asset flows. Section 2 examines January 2020 – March 2020, a period characterized by a sharp equity market selloff. Data presented shows that these equity long/short mutual funds outperformed the S&P 500 during this three-month period (i.e. performed less poorly), though as a group they continued to underperform on a risk adjusted basis. In this period, though, a small number of individual mutual funds did add alpha. Also, extending the analyses over longer time frames ending March 31 2020, a small number of funds generated positive alpha. Finally, Appendix A provides performance data on equity long/short mutual funds begun after July 2013. The performance of this expanded universe of funds is materially the same as mutual funds begun before July 2013.

Performance Sharing in Risky Portfolios: The Case of Hedge Fund Returns and Fees

Institutional investors face various leverage and short-sale restrictions that alter competition in the asset management industry. This distortion enables unconstrained investors with high volatility targets to extract additional income from constrained institutional investors. Using a sample of 1,938 long–short equity hedge funds spanning 15 years, the authors show that high-volatility funds charge higher fees and deliver lower net-of-fees Sharpe ratios than do their low-volatility peers. This evidence could be interpreted as a situational rent extraction or as a service compensation. Conversely, increased volatility could result from a manager’s ambition to deliver large net information ratios after accounting for a high fee structure.

中国股票多头私募证券投资基金的风险因子研究

中国股票多头私募证券投资基金的风险因子研究

Relationship between mutual funds and hedge funds performance in different periods

The hedge fund literature has already shown that hedge funds and mutual funds follow a different strategy. One result of the literature was that mutual funds herd into or out of stocks following the herd of hedge funds one quarter later. The aim of this paper is to find out whether herding behavior of mutual funds have changed after the financial crisis. Our paper compares mutual funds and equity hedge funds in general (not only large hedge funds). The hypothesis is that mutual funds are not herding to equity hedge funds as strong as before the crisis. We use OLS regressions and correlation analysis to test the aforementioned hypothesis. We found that the monthly returns of hedge funds and mutual funds have synchronized in developed markets after the financial crisis. Therefore, the argument that mutual funds herd hedge funds is at least not as strong as before. The improving effectiveness and price informativeness could be an explanation for this changing environment.

Limits of Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

We exploit detailed transaction and position data for a sample of long-short equity hedge funds to document new facts about the trading activity of sophisticated investors. We find that the initiation of both long and short positions is associated with significant abnormal returns, suggesting that the hedge funds in our sample possess investment skill. In contrast, the closing of long and short positions is followed by return continuation, implying that hedge funds close their positions too early and “leave money on the table.” As we demonstrate with a simple model, this behaviour can be explained by hedge funds being (risk) capital constrained and facing position monitoring costs. Consistent with our model, we document that the return continuation following closing orders is more pronounced when these constraints become more binding (e.g., after negative fund returns or increases in volatility).

The Search for Alpha: Have All the Low Hanging Fruits Been Picked? Empirical Evidence from Long/Short Equity Hedge Funds

The Assets under Management of Hedge Funds have increased substantially, according to estimates from HFR from $ 237 Billion in 2000 to $ 2 940 Billion in 2015. At the same time hedge fund performance declined from over 10% per annum before 2000 to below 6% in the new millennium. According to the assumptions of Hsieh and Fung, alpha returns per dollar invested will decrease as long as the supply of alpha is finite. In case the market is dominated by alpha seekers instead of beta chasers, the growth of the hedge fund industry is destined to end. The current development is also consistent with the prediction of Berk and Green (2004) that capital-inflows will ultimately erode performance due to diminishing returns of scale and alpha producing funds decay to beta-only funds over time. Investors are already demanding alternatives, such as low-cost passive indexes or clones, which replicate beta-returns by providing systematic risk exposure to conventional asset-class factors. Besides the ideas for new trading strategies and hedge fund products to generate beta-returns, alpha-returns are, if at all, not easily replicated. Therefore it is necessary to research what kind of returns investors really want and if the increase in assets directly or indirectly causes alpha-returns to diminish. This paper provides empirical evidence on the return-chasing behavior of investors and the existence of long-term performance persistence of hedge fund returns. Additionally the correlation and causal relationship between asset-growth and alpha-returns of Long/Short Equity hedge fund indexes and single hedge funds is examined.

Socially responsible investing in hedge funds

Socially responsible investing (SRI) has gained popularity in recent years, but the evidence is mixed as to whether SRI affects investor returns. We employ several empirical methods to determine the impact of SRI on returns for U.S. equity hedge funds from 2005 to 2015. Using a propensity score matching technique, we find evidence that SRI hedge funds do significantly outperform similar non-SRI Hedge Funds on average by between 1.50 and 2.67 per cent annually. We find similar results for one subcategory of hedge funds using Fama and Macbeth (J Political Econ 81(3):607–636, 1973) regressions, and our findings are stronger when we examine returns from subperiods that do not include the global financial crisis.

Evaluating Investments Using Higher Moments

This paper compares performance of long-short equity hedge funds with the market index by using mean-variance criteria and criteria including higher moments. Based on the mean-variance criteria, the majority of the long-short equity hedge funds outperform the market index. When higher moments are used to evaluate the performance, a greater proportion of the hedge funds underperform the market index. This implies the importance of including higher moments in portfolio optimization.

Overviewing the findings: the Technical Panel Review of the Pension Insurance Modeling System

AbstractThe Pension Benefit Guaranty Corporation's (PBGC) Pension Insurance Modeling System (PIMS) is used to evaluate the financial security and resilience of the national program backstopping private defined benefit plans. The Pension Research Council of the Wharton School at the University of Pennsylvania recently convened a Technical Review Panel of experts to review key inputs, outputs, and model assumptions. Our review was intended to provide a formal evaluation of the technical adequacy of the model by outside experts. The papers herein summarize views of each expert on this project. Key findings are as follows: •The PIMS models are an important and valuable tool in modeling the Pension Benefit Guaranty Corporation's liability risk. To the best of our knowledge, there is no other model that can do a comparable job.•Nevertheless, some improvements could be integrated in the Agency's approach to modeling. Those deserving highest priority attention, in the experts’ view, include incorporating systematic mortality risk (i.e., treat mortality and longevity as stochastic variables); including new asset classes increasingly found in defined benefit plan portfolios (e.g., commercial real estate, private equity funds, infrastructure, hedge funds, and others); developing a more complex model for the term structure of interest rates; and incorporating an option value approach to pricing the insurance provided.•The Agency could also do more to communicate the range of uncertainty and potential for problems associated with the PBGC's financial status. This could include additional information including the conditional value-at-risk, and perhaps an ‘intermediate,’ ‘optimistic’, and ‘pessimistic’ set of projected outcomes, as well as the expected ‘date of exhaustion’ for assets backing pension benefits insured by the PBGC.

Long/Short Equity Hedge Funds and Systematic Ambiguity

This study presents the hedge fund portfolio choice model for an investor facing ambiguity or Knightian uncertainty. In the empirical section, we measure ambiguity as the cross-sectional dispersion in the macroeconomic forecasts and in the stock market return forecasts from the Livingston Survey and construct the systematic ambiguity factors from the universe of S&P 500 stocks. We estimate ambiguity betas for long/short equity hedge funds strategies and document signicant ambiguity exposures for directional L/S hedge funds. We compare the out-of-sample performance of portfolios constructed according to the L/S hedge funds alpha ranking with and without systematic ambiguity exposures and nd that the former outperform. These

Equity Hedge Fund Performance, Cross-Sectional Return Dispersion, and Active Share

Abstract This study examines several aspects of active portfolio management by equity hedge funds between 1996 and 2013. Consistent with the idea that cross-sectional return dispersion is a proxy for the market’s available alpha, our results show that equity hedge funds achieve their strongest performance during periods of elevated dispersion. The performance advantage is robust to numerous risk adjustments. Portfolio managers may use the current month’s dispersion to plan the extent to which the following month’s investment approach will be active or passive. We also estimate the active share for equity hedge funds and find an average of 53%. We further document the average annual expense ratio for managing hedge funds’ active share to be about 7%. This figure is remarkably close to active expense ratios reported previously for equity mutual funds, which may be interpreted as evidence of uniform pricing for active portfolio management services.

Long/Short Equity Hedge Funds and Systematic Ambiguity

This study presents a hedge fund portfolio choice model for an investor facing ambiguity. In the empirical section, we measure ambiguity as the cross-sectional dispersion in Industrial Production growth and in stock market return forecasts, and we construct the systematic ambiguity factors from the universe of S&P 500 stocks. We estimate ambiguity betas for long/short equity hedge funds strategies and document signi cant ambiguity exposures for directional L/S equity hedge funds. We compare the out-of-sample performance of portfolios constructed according to the L/S hedge fund alphas' ranking with and without systematic ambiguity exposures and nd that the former outperform.

Management Insights

Management Insights

Do Hedge Funds Outperform Stocks and Bonds?

Hedge funds' extensive use of derivatives, short selling, and leverage and their dynamic trading strategies create significant nonnormalities in their return distributions. Hence, the traditional performance measures fail to provide an accurate characterization of the relative strength of hedge fund portfolios. This paper uses the utility-based nonparametric and parametric performance measures to determine which hedge fund strategies outperform the U.S. equity and/or bond markets. The results from the realized and simulated return distributions indicate that the long/short equity hedge and emerging markets hedge fund strategies outperform the U.S. equity market, and the long/short equity hedge, multistrategy, managed futures, and global macro hedge fund strategies dominate the U.S. Treasury market. This paper was accepted by Wei Jiang, finance.