Hedge Fund Assets Research Articles

The Hedge Fund Industry Is Bigger (and Has Performed Better) Than You Think

Of first-order importance to the study of potential systemic risks in hedge funds is the aggregate size of the industry. The worldwide hedge fund industry has been estimated by regulators and industry experts as having total net assets under management of $2.3-3.7 trillion as of the end of 2016. Using a newly combined database of several hedge fund information vendors, augmented by the first detailed, systematic regulatory collection of data on large hedge funds in the United States, we estimate that the worldwide net assets under management were at least $5.2 trillion in 2016, over 40% larger than the most generous estimate. Gross assets, which represent the balance sheet value of hedge fund assets, exceeds $8.5 trillion. We further decompose hedge fund assets by their self-reported strategy and by fund domicile. We also show that the total returns earned by funds that report to the public databases are significantly lower than the returns of funds that report only on regulatory filings, both in aggregate and within nearly every fund strategy. This difference appears to be driven entirely by alpha, rather than by differences in exposures to systematic risk factors. However, net investor flows are considerably higher for funds reporting publicly, suggesting previous estimates of the flow-performance relationship are likely biased. Our new, and much larger, estimates of the size of the hedge fund industry should help regulators and prudential authorities to better gauge the systemic risks posed by the industry, and to better evaluate potential data gaps in private funds. Our results also suggest that systematic risk is roughly similar in publicly and non-publicly reporting funds.

Hedge Fund Incentives, Risk Taking, and Asset Prices

Hedge Fund Incentives, Risk Taking, and Asset Prices

Hedge fund attributes, insider behavior, and IPO volatility

In this study, we use regression analysis to explore the influence of hedge fund and insider attributes on the volatility in the excess stock returns for 707 initial public offerings (IPOs). For these tests, we separate stock price volatility into systematic volatility (SVOL) and idiosyncratic volatility (IVOL). Our sample period is for 2004–2010 and thus encompasses the subprime mortgage crisis from 2007 to 2009. During this latter period, the number of hedge funds rose 36% despite the fact the overall size of hedge fund assets fell 38%. We find that hedge funds are more likely to influence systematic volatility and insider behavior is more likely to affect idiosyncratic volatility. SVOL is reduced when there are more hedge funds in the market, hedge fund returns are higher, hedge funds have more assets under management, and the proportion of hedge funds using the relative value (arbitrage) and event driven investment strategies are reduced. A reduction in IVOL is correlated with smaller insider ownership after the offering and greater declines in insider ownership due to the IPO. Our findings are valuable in helping investors and government regulators understand the role hedge funds and other insiders have on stock price volatility.

The Determinants of Increased Short-Selling Activity

Using hedge fund assets and institutional ownership (IO) as proxies for short-selling demand and supply, this paper investigates the determinants of increased short-selling activity on the NYSE/AMEX and NASDAQ from 1988 to 2011. Hedge fund assets, IO and liquidity are significantly related to short-selling activity, and the relationships are stronger in the 2001-2011 period than in the 1988-2000 period. The ownership of short-term hold institutions has a stronger relationship with short-selling activity than ownership of long-term hold institutions. Further, both the expected and unexpected components of short selling have stronger relationships with short-term IO than with long-term IO.

Hedge Fund Illiquidity, Age, and Performance

This article shows that hedge fund performance is positively related to funds’ exposure to illiquid assets. Therefore, because older funds and funds with larger increases in assets under management tend to invest less in illiquid assets, these funds tend to have weaker performance. The results for fund age hold for every major category of hedge fund and across the time period examined. In addition, the results hold even when controlling for the size of hedge fund assets. The age effect is strongest for volatile funds that are focused on security selection. The first implication of the article is that hedge fund investors who focus on older funds with long track records may generate disappointing results, especially if these funds are still rapidly growing their assets. A second implication is that investors considering investing in older funds and in funds that have grown considerably need to establish whether the fund has the same mix of liquid and illiquid investments it had in prior years. A third implication is that liquid-alternative products are unlikely to perform well, because they cannot hold the types of illiquid investments that are strongly associated with hedge fund performance.

The Dynamics of Market Efficiency

We study the dynamics of high-frequency market efficiency measures. We provide evidence that these measures comove across stocks and with each other, suggesting the existence of a systematic market efficiency component. In vector autoregressions, we show that shocks to funding liquidity (the TED spread), hedge fund assets under management, and a proxy for algorithmic trading are significantly associated with systematic market efficiency. Thus, stock market efficiency is prone to systematic fluctuations, and, consistent with recent theories, events and policies that impact funding liquidity can affect the aggregate degree of price efficiency.

The anatomy of the Cayman Islands offshore financial center: Anglo-America, Japan, and the role of hedge funds

ABSTRACTThe Cayman Islands is a key node in contemporary global finance, yet it is severely under-researched. This paper compiles the first ‘anatomy’ of the Cayman offshore financial center (OFC), utilizing all sources of publicly available data about the three main segments: banking, direct investment, and portfolio investment. The analysis is performed both diachronically to see when large inflows occurred and geographically to determine what role certain countries play in different segments. This dissection of the Cayman OFC shows that the United States is the largest counterparty in all segments with Japan playing an important role too. In fact, when excluding long-term Treasuries, Cayman is the largest holder of US securities in the world. Hedge funds are the main factor for this strong Cayman-US link. About 60% of global hedge fund assets are legally domiciled in Cayman – an extraordinary spatial concentration in such a tiny jurisdiction. A novel contribution to the analysis of the Cayman OFC is the introduction of the Anglo-America/Anglosphere approach. This approach provides one plausible explanation for the unparalleled rise of the Cayman OFC by seeing this jurisdiction as one node in an Anglo-American triangle together with the USA and the UK, Cayman's sovereign power.

Commonality in Market Efficiency

This paper studies the dynamics of high-frequency market efficiency measures. We provide evidence that these measures co-move across stocks and with each other, suggesting the existence of a systematic market efficiency component. In vector autoregressions, we show that shocks to funding liquidity (the TED spread), hedge fund assets under management, and a proxy for algorithmic trading are significantly associated with systematic market efficiency. Thus, stock market efficiency is prone to systematic fluctuations, and, consistent with recent theories, events and policies that impact funding liquidity can affect the aggregate degree of price efficiency.

Transparency in the Extractive Industries: Time to Ask for More

The quest for transparency spans countries, policymakers, NGOs, and industries.Transparency can be defined as disclosing to the public, in a timely and reliable manner, information that governments and/or corporations previously con-sidered confidential. Recent examples include the Carbon Disclosure Project,the Aarhus convention on access to environmental information, the Cartagena Protocol on Biosafety and its provisions on global genetically modified organism flows, and a wide array of financial information (e.g., in the G8 declaration of Lough Erne in 2013). Stemming from the “right to know,”advocates from NGOs and development organizations view transparency as a cure for corruption and a benefit for democratic accountability; transparency should lead to stakeholder empowerment and improve legitimacy, learning, investment certainty, and better governance. In this article I look at the efforts to establish financial transparency as a norm for the extractive sector. This sector is important because its activities are accompanied by a high level of corruption, especially in resource-rich developing countries. I show that those efforts are not enough and there is good evidence to demand more. I argue that such transparency norms should be extended to environmental pressures in order to facilitate progress on the circular economy and resource efficiency. My conclusions point at synergies between knowledge generation across financial and environmental information.

Have capital market anomalies attenuated in the recent era of high liquidity and trading activity?

We examine whether the recent regime of increased liquidity and trading activity is associated with attenuation of prominent equity return anomalies due to increased arbitrage. We find that the majority of the anomalies have attenuated and the average returns from a portfolio strategy based on prominent anomalies have approximately halved after decimalization. We provide evidence that hedge fund assets under management, short interest and aggregate share turnover have led to the decline in anomaly-based trading strategy profits in recent years. Overall, our work indicates that policies to stimulate liquidity and ameliorate trading costs improve capital market efficiency.

Why Do Short Interests Predict Returns? Over-Valuation and Information

We decompose short interest into the component related to short sale constraints and the component related to informed trading. We find that the predictability of short sale constraints is stronger for stocks with low institutional ownership, while the predictability of informed trading is not related to institutional ownership. After large increases in institutional ownership and hedge fund assets in the second half of the sample period, the relationship between short sale constraints and future stock returns becomes weak, while that between informed trading and future stock returns remains the same. Our results provide evidence that stocks will be overpriced in the presence of short sale constraints modeled in Miller(1977) after controlling for informed trading.

Cumulant instrument estimators for hedge fund return models with errors in variables

We revisit the factors incorporated in asset pricing models following the recent developments in financial markets – i.e., the rise of shadow banking and the change in the transmission channel of monetary policy. We propose two versions of the Fung and Hsieh (2004) hedge fund return model, especially an augmented market model which accounts for the new dynamics of financial markets and the procyclicality of hedge fund returns. We run these models with an innovative Hausman procedure, tackling the measurement errors embedded in the models factor loadings. Our empirical method also allows for confronting the drawbacks of the instruments used to estimate hedge fund asset pricing models.

Sizing the European Shadow Banking System: A New Methodology

One of the critical unanswered questions relating to the shadow-banking system has been to quantify its scale in an industry where entities, by design, are opaque and often outside of regulated and publically shared frameworks. However almost all shadow banking entities, including hedge funds, private equity funds and special purpose vehicles (SPVs), interact with the financial markets via regulated investment banks. For example, many SPVs are in fact originated as part of investment banking business and hedge funds typically transact in financial markets exclusively via the prime brokerage division of investment banks. This interface with the regulated banking environment combines with the typical practise by investment banks of equalizing compensation (Including bonus) ratios to revenues globally which then allows identification of the implied difference in revenues and hence assets that represents the shadow banking system. The paper will present for critique the results of this methodology to estimate the UK shadow banking system including European business managed from the UK. The estimate will imply a larger scale of shadow banking than previous estimates at £548 billion which, when combined with hedge fund assets of £360 billion (FSA, 2011) gives total shadow banking assets of over £900 billion. It is proposed that the large gap between the estimates of this paper and other estimates reflects the huge, and previously unknown, scale of offshore activities of UK investment banks.

Hedge funds and unconscious fantasy

PurposeThis paper aims to help explain the rapid growth in aggregate hedge fund assets under management until June 2008 followed by their subsequent dramatic collapse in terms of the conflicting emotions such investment vehicles evoke, and, from this, to consider the implications of the excitement‐generating potential underlying all financial innovations.Design/methodology/approachWithin the framework of critical discourse analysis, this paper explores how hedge funds were represented in the financial press, manager interviews, investor comments, and Congress hearings, before and after the burst of the hedge fund “bubble”. The authors then draw on the psychodynamic literature, and frame the human unconscious need for excitement in this discourse.FindingsThe paper finds evidence demonstrating how hedge funds were transformed in the minds of investors into objects of fascination and desire with their unconscious representation dominating their original investment purpose. Based on a psychoanalytic interpretation of financial markets, and dot.com mania in particular, the authors show how hedge fund investors' search for “phantastic objects” and the associated excitement of being invested in them can become dominant, resulting in risk being ignored.Research limitations/implicationsThe authors take an interdisciplinary perspective drawing on the insights of the psychoanalytic understanding of unconscious fantasies, needs and drives as these relate to investment activity.Practical implicationsPublic policy implications are that stricter ethical guidelines for the hedge fund industry need to be introduced, and suitability regulations that go beyond mandatory transparent disclosure of investment risks are required.Originality/valueThe paper is one of very few studies concerning investors' emotional attachment to financial innovations, and builds on the emerging field of emotional finance. The conclusions and implications discussed in the paper go beyond any single financial market or product.

Tales from the Downside: Risk Reduction Strategies

High market volatility has driven the development of investment strategies advertised to deliver reduced risk without reduced return. The “low-volatility” equity anomaly (low-risk stocks may have similar or greater returns than high-risk stocks) is best exploited by investors as part of the toolkit of a broader active strategy. “Tail risk” strategies can provide protection in extreme market events, but their persistent negative carry (ongoing cost) make them unappealing to most investors. Managed futures and global macro hedge fund strategies have desirable downside risk protection characteristics combined with positive returns and alpha for skilled investors. Investors can increase their downside protection by allocating part of their hedge fund or opportunistic asset category to managed futures and global macro strategies.

Trends in the Cross-Section of Expected Stock Returns

We examine whether the recent regime of increased liquidity and trading activity is associated with attenuation of prominent equity return anomalies due to increased arbitrage. We find that the majority of the anomalies have attenuated, and the average returns from a portfolio strategy based on prominent anomalies have approximately halved after decimalization. We provide evidence that hedge fund assets under management, short interest and aggregate share turnover have led to the decline in anomaly-based trading strategy profits in recent years. Overall, our work indicates that policies to stimulate liquidity and ameliorate trading costs improve capital market efficiency.

Going, Going, Gone? The Apparent Demise of the Accruals Anomaly

Consistent with public statements made by sophisticated practitioners, we document that the hedge returns to Sloan's (Sloan, R. G. 1996. Do stock prices fully reflect information in accruals and cash flows about future earnings? Accounting Rev. 71(3) 289–315) accruals anomaly appear to have decayed in U.S. stock markets to the point that they are, on average, no longer reliably positive. We explore some potential reasons why this has happened. Our empirical analyses suggest that the anomaly's demise stems in part from an increase in the amount of capital invested by hedge funds into exploiting it, as measured by hedge fund assets under management and trading volume in extreme accrual firms. A decline in the size of the accrual mispricing signal, as measured by the magnitude of extreme decile accruals and the relative persistence of cash flows and accruals, may also play a (weaker) role. This paper was accepted by Stefan Reichelstein, accounting.

The ABCs of Hedge Funds: Alphas, Betas, & Costs

Despite the retrenchment of the hedge fund industry in 2008, hedge fund assets under management are currently over one and a half trillion dollars. We analyze the potential biases in reported hedge fund returns, in particular survivor-ship bias and back fill bias. We then decompose the returns into three components: the systematic market exposure (beta), the value added by hedge funds (alpha), and the hedge fund fees (costs). We analyze the performance of a universe of about 8,400 hedge funds from the TASS database from January 1995 through December 2009. Our results indicate that both survivor-ship and back fill biases are potentially serious problems. Adjusting for these biases brings the net return from 14.26% to 7.63% for the equally weighted sample. Over the entire period, this return is slightly lower than the S&P 500 return of 8.04%, but includes a statistically significant positive alpha. We estimate a pre-fee return of 11.42%, which we split into a fee (3.78%), an alpha (3.01%), and a beta return (4.62%). The positive alpha is quite remarkable, since the mutual fund industry in aggregate does not produce alpha net of fees. The year by year results also show that alphas from hedge funds were positive during every year of the last decade, even through the recent financial crisis of 2008 and 2009.

Going, Going, Gone? The Demise of the Accruals Anomaly

Consistent with public statements made by sophisticated practitioners, we show that the hedge returns to Sloan's (1996) accruals anomaly have decayed in U.S. markets to the point that they are no longer positive. While we cannot unambiguously identify the causal factor or factors involved, our empirical analyses suggest that the anomaly's demise stems at least in part from a decline in the size of the mispricing signal (as measured by accruals in the extreme accruals deciles and the relative persistence of cash flows and accruals) and an increase in the capital invested by hedge funds into exploiting the signal (as measured by hedge fund assets under management and trading volume in extreme accrual decile firms). In light of the roles played by academic accountants in discovering and exploiting the accruals anomaly, we conclude that accounting scholarship can causally affect, not just associatively study, capital market prices and efficiency.

US hedge fund oversight in the aftermath of Madoff: finding the right balance

The revelation en masse of fraudulent schemes among US asset managers has led many to question whether regulators could have exercised more effective oversight and, if so, what shape such oversight should have taken. US lawmakers have reintroduced legislation that would make a large number of hedge fund and other asset managers with links to US investors register as investment advisers under the US Investment Advisers Act of 1940, among other measures. Studied scrutiny of the Advisers Act suggests that, despite its virtues, it does not sufficiently segregate functions where investment advisers also act as broker-dealers and custodians nor does it cause the regulator to seek independent information on the adviser's activities. Comparative analysis with provisions of UK and Irish law applicable to investment advisers leads to a tentative conclusion that applicable regulation can and should prohibit investment advisers from simultaneously fulfilling custodial functions. In addition, regulators can look to custodians and depositaries—parties with day-to-day contact with the investment adviser—as independent sources of information on an investment adviser's activities. Together, measures of this nature can act to strengthen oversight under the Advisers Act.