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Mutual/Hedge Funds

Do investors in mutual funds and hedge funds get their fair share of returns, or are they perpetually disadvantaged by fees and underperforming fund managers? Are there ways to exploit fund behaviors? These blog entries relate to mutual funds and hedge funds.

Due Diligence on Hedge Funds

What does due diligence discover about hedge funds? If outperformance attracts due diligence investigations, does this outperformance persist after the investigations? In the June 2009 draft of their paper entitled “Trust and Delegation”, Stephen Brown, William Goetzmann, Bing Liang and Christopher Schwarz characterize the findings of formal hedge fund due diligence investigations and measure their timing with respect to fund performance. Using a sample of 444 hedge fund due diligence reports (typically 100-200 pages each) from a major hedge fund due diligence firm spanning 2003-2008, along with associated fund performance data, they conclude that: Keep Reading

The Value of Fundamental Investment Research?

Is it possible to measure the value of fundamental investment research? How does the degree of measurability affect the behaviors of investors and financial markets? In the June 2009 version of his paper entitled “Investment Research: How Much is Enough?”, Bradford Cornell speculates on answers to these questions. Citing a range of research on mutual fund research practices and performance, he concludes that: Keep Reading

Best Ideas of Mutual Fund Managers

How many stocks within an equity fund manager’s portfolio represent truly “passionate” (high-conviction) picks? Do passionate picks outperform the diversifying “fillers” in the portfolio, and the market in general? In the March 2009 version of their paper entitled “Best Ideas”, Randy Cohen, Christopher Polk, and Bernhard Silli attempt to identify which holdings in equity mutual fund portfolios represent the high-conviction “Best Ideas” of the fund managers and then measure the performance those stocks after the conviction becomes apparent. They identify high-conviction holdings via several measures that indicate unusually high commitment (tilt) of funds to specific stocks, with the “Best Idea” in a portfolio being the stock with the highest tilt. Using monthly stock returns and quarterly fund holdings data for U.S. equity mutual funds over the period 1991-2005, they conclude that: Keep Reading

Mutual Fund Stock Selection vs. Market Timing

Can investors assess the performance of an active fund manager without access to the fund’s detailed trading records (especially trades not evident from quarterly holdings reports)? In the February 2009 update of his paper entitled “Active Alpha and Active Beta – Detecting the Unobserved Actions of Portfolio Managers”, Anders Ekholm presents a new methodology for indirectly measuring the effects of a fund manager’s trading that relies exclusively on portfolio returns. His approach decomposes fund tracking error into two aspects of active management: stock selection (idiosyncratic risk, or active alpha) and general market timing (systemic risk, or active beta). Applying this methodology to daily returns for a sample of actively managed U.S. equity mutual funds over the period 12/31/99-3/31/08, he finds that: Keep Reading

Morningstar Ratings and Future Returns

Does the Morningstar mutual fund rating system work? If so, how? In their March 2009 paper entitled “Selectivity, Market Timing and the Morningstar Star-Rating System”, Antonios Antypas, Guglielmo Caporale, Nikolaos Kourogenis and Nikitas Pittis investigate whether Morningstar mutual fund ratings enable investors to select funds that are likely to outperform in the future. Using data for 1,511 rated equity mutual funds since January 1998, they conclude that: Keep Reading

Actual Return Experience of Hedge Fund Investors

Do hedge fund investors actually receive the returns reported for hedge funds, or does the timing of investments in these funds substantially affect experienced returns? In the March 2009 version of their paper entitled “Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn”, Ilia Dichev and Gwen Yu measure actual hedge fund investor returns by integrating the returns of the funds they hold with the timing and magnitude of their capital flows into and out of these funds. Specifically, they calculate an aggregate internal rate of return (dollar-weighted return) that treats funds as time-ordered investor capital flows, with initial fund market value and fund inflows counted as negative flows and fund outflows and ending market value counted as positive flows. Using monthly net-of-fee return and assets under management data for a large sample of hedge funds over the period 1980-2006, they conclude that: Keep Reading

The Mutual Fund Research Newsletter Quarterly Asset Class Allocations

A reader requested: “Would you add Tom Madell’s Mutual Fund Research Newsletter to Guru Grades?” The most consistent thread in the Mutual Fund Research Newsletter archive for 2000-2008 [no longer publicly available] is the quarterly asset class allocation (stocks, bonds, cash) recommendation. Variation in recommended allocations across nine years supports a rough assessment of general market timing value. This assessment is related to, but more quantitative than, the narrative forecast reviews for other experts at Guru Grades. Because of this difference, we are not including Tom Madell in the list of experts at Guru Grades. Using the 36 Mutual Fund Research Newsletter quarterly asset class allocation recommendations, along with contemporaneous quarterly returns for proxy assets, we conclude that: Keep Reading

Hedge Fund Size Effect

Do small hedge funds tend to prosper in their chosen niches while large ones outgrow their opportunity sets? In his January 2009 paper entitled “Does Size Matter in the Hedge Fund Industry?”, Melvyn Teo examines the relationship between hedge fund size and future risk-adjusted (for seven factors) returns. Using monthly net-of-fee returns, assets managed and other characteristics for a large sample of live (3,177) and dead (4,240) hedge funds allocated to four styles over the period January 1994 through June 2008, he concludes that: Keep Reading

New Funds Outperform?

Do new mutual funds bring fresh alpha to the marketplace, outperforming until the market catches up and extinguishes it? In their August 2008 paper entitled “Performance and Characteristics of Mutual Fund Starts”, Aymen Karoui and Iwan Meier examine the performance and portfolio characteristics of U.S. equity mutual funds launched during 1991-2005. Using monthly return, quarterly holdings and fund characteristics/fee data for 1,374 U.S. domestic equity mutual funds and 828 fund starts over this period, they conclude that: Keep Reading

Hedge Fund Outperformance: Skill or Liquidity Risk?

Can outperforming hedge funds readily convert assets into cash for fund investors? In their October 2008 paper entitled “Hedge Fund Alphas: Do They Reflect Managerial Skills or Mere Compensation for Liquidity Risk Bearing?”, Rajna Gibson and Songtao Wang study the effect of market-wide liquidity risk (the time and costs of transforming a given position into cash and vice versa) on the performance of various hedge fund portfolio strategies. The strategies they consider are: Convertible Arbitrage, Dedicated Short Bias, Emerging Markets, Equity Market Neutral, Event-Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity Hedge, Managed Futures and Multi-Strategy. Using performance data for a broad sample of live (2,743) and defunct (1,955) hedge funds during 1994-2006 and contemporaneous measures of market-wide (U.S. equities) liquidity, they conclude that: Keep Reading

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