Hedge Fund Managers Research Articles

The macroeconomic drivers in hedge fund beta management

We investigate how macroeconomic indicators alter the dynamic risk exposure of different hedge fund style strategies. We implement a multifactor model to estimate the unobservable time-varying risk exposure conditional on macroeconomic information and a VAR to measure the impact of macroeconomic predictors on different time horizons. Using monthly returns on a cross-section of 10 different style indices from February 1997 to August 2019, we find that, on average, macroeconomic indicators explain approximately 30%, 55%, and 75% of the variability of betas at 1-, 6-, and 36-month horizons, respectively. Although macroeconomic predictors play a critical role at every horizon, at 1 month, the dominating effect comes from idiosyncratic shocks, which indicates that in the short run, hedge fund managers rely mostly on their own reallocation signals. Moreover, consistent with the fundamental drivers of the smart beta factors, we find that the interest rate level and GDP growth similarly impact hedge fund exposures across styles.

Manager Characteristics and Hedge Fund Returns, Liquidity, and Survival

Existing empirical studies assert that there is significant cross-sectional variation in the risk-adjusted returns of hedge funds, and that their performance is affected by manager characteristics such as education. However, when analyzing the impact of manager characteristics, prior research does not control for the difference in liquidity. In this study we find that manager education affects the liquidity of hedge fund shares and assets; on average, managers educated in elite institutions impose stronger share restrictions and thus can better manage illiquid assets to generate a liquidity premium. We also find that manager education affects the survival of hedge funds, but that the CFA designation has a stronger impact. From 1994 to 2015, the hazard rate of CFA funds was 13.6% lower, and the difference was significant after controlling for risk, return, and investment style effects. Our findings are important because the search and due diligence process is costly for investors such as pension funds—and survival rates reduce costs. TOPICS:Performance measurement, manager selection, style investing Key Findings • Manager characteristics such as education affect the liquidity of hedge fund shares and assets. On average, hedge funds whose managers were educated in elite institutions imposed stronger share restrictions and invested in more illiquid assets than other funds did. • Share restrictions enable funds to better manage illiquid assets, and the skills and alumni networks of managers contribute to this advantage. This article shows that the major driving force is trust inspired by the reputation and network of elite institutions. • The educational backgrounds and certification of hedge fund managers are related not only to the liquidity premium that long-horizon investors can earn, but also to the lower search costs due to the higher survival rates.

The All-Weather Portfolio Approach: Analysis of the Strategy on a 10-Year Timeframe, Insights and Investment Lessons

This research article aims to analyze the All-Weather strategy advocated by the very famous hedge fund manager Ray Dalio. Through an analysis of nearly 10-year of market data, we have selected ETF funds to replicate the investment principle by using a classic approach and an approach on steroids by incorporating double-leveraged ETF funds to increase the performance of this portfolio. We present the different results that suggest an overall performance that converge with the original analysis proposed in the Bridgewater Associates (2009) research paper that shows the benefits of the All-Weather approach on the overall portfolio risk/return trade-off.

Practical Applications of Holdings Concentration and Hedge Fund Investment Strategies

Practical Applications In Holdings Concentration and Hedge Fund Investment Strategies, published in the Spring 2020 issue of The Journal of Alternative Investments, Xiaohui Yang (Fairleigh Dickinson University) and Hossein Kazemi (University of Massachusetts Amherst) investigate whether hedge fund managers are skilled stock pickers and can earn abnormal risk-adjusted returns. By focusing on the proportion of a stock that a hedge fund holds relative to the stock’s proportion in its benchmark, the authors note that the concentrated stocks outperform the least-concentrated stocks under most conditions. The analysis provides insights on market efficiency because certain stock prices do not immediately reflect publicly available holdings information. The study considers the relative performance of small-cap and large-cap stocks with high holding concentrations in crisis and non-crisis conditions. By simulating strategies based on holding concentrations, the authors examine risk-adjusted returns as well as downside risks. They conclude that investors can potentially use publicly available hedge fund information to create a profitable investment strategy. TOPICS:Real assets/alternative investments/private equity, portfolio construction, performance measurement

Option-like properties in the distribution of hedge fund returns

In recent years hedge funds have become more popular because of their low correlation with traditional investments and their ability to generate positive returns with a relatively low volatility. However, a closer look at those high performing hedge funds raises the question if the performance is truly superior and if the high management fees are justified. Incurring no alpha costs, so-called passive hedge fund replication strategies raise the question if they can lead to similar performance in a more efficient way at lower costs. This paper investigates two different model approaches for the equity long/short strategy, where weighted segmented linear regression models are employed in combination with two-state Markov switching models. The main finding is evidence of a short put option structure, i.e. short the equity market volatility, with the put structure present in all market states. We obtain evidence that the hedge fund managers decrease their short-volatility profile during turbulent markets.

Self-fulfilling arbitrages necessitate crash risk

We propose a model in which hedge funds can initiate a sequence of arbitrage opportunities and a potential market crash without any exogenous shock. When hedge fund managers share a concern about a rare event, not necessarily affecting the fundamentals, some hedge funds may opt out for fear of redemption risk, leading to coordination failure. Our model demonstrates that the coordination failure generates an arbitrage opportunity but it comes with a chance of a market crash. It explains hedge funds’ low leverage before the recent financial crisis and discusses their conflicting features of causing a financial crisis and enhancing market efficiency.

Holdings Concentration and Hedge Fund Investment Strategies

This article examines the risk–return performance of concentrated positions of hedge funds in large-cap and small-cap stocks. The research shows that small-cap stocks in which hedge funds have concentrated positions earn higher future returns than those that are not part of hedge funds’ concentrated holdings. Also, stocks that are part of the concentrated positions of hedge funds display higher downside risks and relatively large downside returns during periods of market turmoil. The results presented indicate that hedge fund managers are skilled in making equity investments under different degrees of market efficiency. The authors’ findings have two practical implications: (1) hedge funds that hold concentrated positions in small-cap stocks may outperform their peers and (2) investors may be able to improve the performance of their equity portfolios by monitoring hedge funds’ positions in small-cap stocks. TOPICS:Real assets/alternative investments/private equity, portfolio construction, performance measurement Key Findings • Stocks in which hedge funds have concentrated positions earn higher future returns and display higher downside risks than those that are not part of hedge funds’ concentrated holdings. • The above-mentioned effects associated with hedge funds’ concentrated positions are stronger for small-cap stocks than large-cap stocks. • Results imply that monitoring hedge funds’ positions, especially in small-cap stocks, may improve the performance investors’ equity portfolios.

Optimal risk taking under high-water mark contract with jump risk

This paper studies the effects of jump risk in returns on the hedge fund manager’s optimal risk taking under high-water mark contract. The results show that the fund manager’s optimal risk taking under jump-diffusion risk is not a simple combination of that under pure-jump risk and pure-diffusion risk. The increase in jump intensity and jump size discourages the fund manager’s risk choice.

Fraud against hedge funds: implications to operational risk and due diligence

PurposeThe loss of an amount in excess of $100m cash deposit can be disruptive to the operations, definitely the liquidity of the hedge fund. Should a hedge fund liquidity position deteriorate, its compromised solvency could impact its vendors, most notably creditors and prime brokers. Large successful hedge funds do make basic mistakes. Lawyer Marc Dreier committed the criminal act of selling fraudulent promissory notes to hedge funds and others. Mr Drier’s success in selling fraudulent promissory notes was facilitated by his accomplices who posed as fake representatives of legitimate institutions. Drier and team presented bogus “audited financial statements” and forged developer’s signatures, and even went as far as using the unsuspecting institutions’ premises for meetings to meet potential notes buyers to further falsely legitimize the scheme. He had the notes buyers send their payments to his law firm account, to secure the money. His actions cost his victims, who include 13 hedge fund managers, other investors and entities, $400m in addition to his law firm’s employees who also suffered when his law firm was dissolved. For his actions, he was sentenced 20 years in federal prison for investment fraud. This study aims to direct hedge fund investors and other stakeholders to thoroughly vet the compliance function, especially controls on cash disbursements, even if the hedge fund is sizable (in excess of $1bn). Investors and even other stakeholders also should place a greater focus on what is usually overlooked issue; most notably the credit quality and authenticity of short-term investments bought by their hedge funds.Design/methodology/approachA thorough investigation of a fraud committed by a lawyer against a number of hedge funds. Several important lessons are identified to professionals who conduct due diligence on hedge funds.FindingsThe details of the case are very remarkable. This case directs investors’ attention to place greater efforts on certain aspects of operational risk and due diligence on not only hedge funds but also other investment managers. Normally investors conduct operational due diligence on the fund and its operations. Investors also vet fund external parties such as prime brokers, custodians, accountants and fund administrators. Yet, investors normally do not suspect the quality of short-term fund investments. In this case, the short-terms investments were the source of unforeseen yet substantial risk.Research limitations/implicationsStakeholders in hedge funds need to carefully investigate the issuer of and the quality of short-term investments that a hedge fund invests in. Future research can investigate the association of hedge fund manager failure with a liquidity position of the fund.Practical implicationsInvestors must thoroughly the entirety of the fund including short-term securities.Originality/valueNormally, it is the hedge funds that commit the fraud against investors. In this case, it is the multi-billion hedge funds run by sophisticated fund managers, who are the victims.

On the optimal strategy for the hedge fund manager:An experimental investigation

This paper examines the empirical validity of Nicolosi’s optimal strategy for a hedge fund manager under a specific payment contract. The contract specifies that the manager’s payment consists of a...

When Paid Work Gives in to Unpaid Care Work: Evidence from the Hedge Fund Industry under COVID-19

We examine how childcare inequalities in the home affect the work productivity of female talent, using unique data on the family structures of hedge fund managers, and the exogenous shock from school closures during the early Covid-19 pandemic response. We find that female managers' ability to generate abnormal returns is curbed by 9% on average in the shock-month of school closures, providing a direct measure of the cost of unpaid care work. This effect is driven by mothers and especially mothers with young children. With increasing calls for more women representation in all layers of the economy and the efforts exerted towards that goal, there is reason for concern that these efforts might not factor in, as the pandemic has uncovered how women in general and mothers in particular bear both the burden of unpaid care work, and the subsequent cost to their paid work.

Hedge Fund Family Ties

Using a novel dataset, I show that hedge fund managers connected through shared employment histories hold and co-trade more of the same stocks than unconnected managers. Results are greater between fund pairs with stronger social connections and longer dated relationships, implying a socially reinforcing channel is responsible. A long-short portfolio of overlapped socially connected versus unconnected stocks generates alpha of 13.3% per year. Findings herein support models of manager coordination and identifies employment linked hedge funds as a common source of correlated risk and return.

Hedge fund’s dynamic leverage decisions under time-inconsistent preferences

We extend the continuous-time hedge fund framework to model the dynamic leverage choice of a hedge fund manager with time-inconsistent preferences. While time-inconsistency discourages the manager from investing when facing high liquidation risk, the payment of incentive fees may induce a time-inconsistent manager to be more aggressive with leverage. For the special case with no management fees, we derive the closed-form solutions and find that a time-inconsistent manager always chooses higher leverage than a time-consistent manager. The impact on the dynamic leverage strategy also depends on such factors as whether managers are sophisticated or naive in their expectations regarding future time-inconsistent behavior.

Trading Under Uncertainty About Other Market Participants

I present an asymmetric information model of financial markets that features rational, but uninformed, hedge fund managers who trade against informed and noise traders. Managers are uncertain not only about fundamentals, but also about the proportion of informed to noise traders in the market and use prices to update their beliefs about these uncertainties. Extreme news leads to an increase in both types of uncertainty, while it decreases price informativeness. Prices react asymmetrically to positive and negative news, with higher expected returns at times of increased uncertainty about market composition. The model generates a price-volume relationship that is consistent with established stylized facts. I then extend to a three-period model and study the dynamics of expected returns and volatility.

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.

Short Selling Risk and Hedge Fund Performance

Hedge funds, on average, outperform other actively managed funds. However, hedge fund managers often use trading strategies that are not used by other managed portfolios, and thus they bear unique risks. In particular, many hedge funds use short selling. I construct an option-based measure of short selling risk as the return spread between the decile of stocks with low option-implied short selling fees and the decile of those with high fees. I find that hedge funds that are significantly exposed to short selling risk outperform low-exposure funds by 0.45% per month on a risk-adjusted basis. However, there is no such relation for mutual funds that invest primarily on the long side. The results highlight that a significant proportion of abnormal performance of hedge funds is compensation for the risk they take on their short positions.

Networks for Alpha: Prime Broker Connections and Hedge Fund Manager Selection

Using the setting of funds of hedge funds (FoFs), we show that prime brokers (PBs) facilitate investors' search for informed hedge fund managers. We find that FoFs exhibit PB bias, a disproportionate preference for hedge funds serviced by their connected PBs. This PB bias is stronger when the cost of hedge fund due diligence is higher relative to capital and when the FoF's management firm generates higher prime brokerage fees. PB bias also predicts FoF performance: the highest PB-bias quartile outperforms the rest by 2.08%-2.45% per annum, after adjusting for differences in their risks.

When It Pays to Follow the Crowd: Strategy Conformity and CTA Performance

Prior research in hedge fund and mutual fund management finds a positive relation between portfolio distinctiveness and subsequent performance, suggesting that strategy differentiation is associated with superior skill. We find that CTAs with returns that correlate more strongly with those of peers feature higher performance and are more highly exposed to a time series momentum factor. In contrast to hedge funds and mutual funds, CTA strategy conformity appears to be a signal of managerial skill. These results indicate that a common trend following strategy drives CTA returns and that CTAs offer investors an opportunity to invest in momentum.

Alpha, Beta and the Endowment Model

Alpha, or outperformance of a benchmark, can be generated in many ways within a portfolio. It can be created by picking the top hedge fund managers, or by capturing the illiquidity premium via alternative assets. Venture capital is a major source of alpha for long-term investors. Alpha can also be achieved by active asset allocation using both tactical and strategic beta tilts. For the top endowments, these and other innovative portfolio decisions have created great, long-term alpha versus a global balanced benchmark with 70% stocks/30% bonds. Since asset allocation plays a large role in determining portfolio returns, it is interesting to compare how beta (or index fund) portfolios have compared historically versus sophisticated institutional portfolios. We compare 3 decades of performance: the 10 year period before the Internet Bubble’s peak (FY1988-1998), the 10 years including fiscal year 2000’s spectacular gains (FY1998-2008), and a more recent period (FY2008-2018). The Endowment Model will no doubt continue to help colleges to fulfill their missions, and enable public pensions to meet their retirement obligations. However, for some investors, over-diversification can dilute manager alpha and lead to performance that is similar to beta portfolios. Given its complexity, the Endowment Model is not a one-size-fits-all strategy, and is best suited for larger investment teams with considerable resources. For those institutions constrained by limited resources, using a balance of alternative assets and beta could achieve the best of both worlds. For instance, mid-sized investors might be better served by streamlining their portfolios with a liquid beta core, coupled with satellite alternative assets. And smaller investors could only use index fund portfolios and still achieve alpha. An index fund portfolio may be no substitute for a world-class endowment fund, but it could be an ideal investment solution for some long-term investors.

Investor, local providers join forces to fill service gaps for veterans

Partnerships between local mental health providers and an organization financed by billionaire investor and hedge fund manager Steven Cohen are giving rise to low‐cost clinics to meet the needs of post‐9/11 military veterans and their families. Rather than being seen as an alternative to veterans services provided by the U.S. Department of Veterans Affairs (VA), the care delivered at these facilities fills gaps in communities with a heavy military/veteran presence, with the VA often serving as the primary referral source for these sites.