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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.

Pros and Cons of 130/30 Funds

Should investors shift from traditional long-only mutual funds to newer and more flexible 130/30 (130% long/30% short) equity funds? In other words, does the flexibility of 130/30 funds to short stocks and expand portfolios enhance returns? In the May 2008 version of his paper entitled “130/30 Investing: Just Another Hype or Here to Stay?”, David Blitz enumerates theoretical advantages and disadvantages of 130/30 investing and discusses ways in which 130/30 fund managers are implementing their flexibility, concluding that: Keep Reading

Redemption Fees Signal Mutual Fund Outperformance?

Should investors avoid mutual funds that charge redemption fees, or is there a good reason to accept this explicit hit to liquidity? In other words, do these fees protect underperforming fund managers or long-term investors? In their recent paper entitled “Redemption Fees: Reward for Punishment”, David Nanigian, Michael Finke and William Waller study the impact of short-term redemption fees on long-term fund performance based on fee size and duration (effective time interval of the redemption fee after purchase). Using monthly after-tax returns for a very large sample of open-end US equity mutual funds over the period July 2003 to May 2007, they conclude that: Keep Reading

The Outperformance of (Truly) New Hedge Funds

Do strong incentives for new hedge fund managers and small-fund nimbleness translate to outperformance for new funds? In the January 2008 draft of their paper entitled “The Performance of Emerging Hedge Fund Managers”, Rajesh Aggarwal and Philippe Jorion analyze the performance of new hedge funds, emphasizing avoidance of backfill bias. New fund managers may at their discretion “back fill” past performance when they decide to start reporting fund performance. The authors account for the potential bias of favorable backfilling by assembling a sample of funds with inception dates within 180 days of first report dates. Using return data for the resulting sample of 923 (both live and dead) hedge funds that are new over the period 1996-2006, they conclude that: Keep Reading

Institutional Trading, Returns and Strength of Anomalies

Are there exploitable differences in returns for stocks with heavy versus light institutional trading activity? In his March 2008 paper entitled “Trader Composition and the Cross-Section of Stock Returns”, Tao Shu analyzes the impact of institutional trading activity on the returns of individual stocks and on the strength of the momentum effect, post earnings-announcement drift (PEAD), the value premium and the investment effect. He calculates institutional trading activity at a quarterly frequency by dividing the aggregate absolute change in reported institutional holdings of a stock by the contemporaneous total quarterly trading volume for the stock. Using holdings data as reported via SEC Form 13F and associated stock trading volume and return data for the period 1980-2005, he concludes that: Keep Reading

Filtering the Luck Out of Mutual Fund Performance Data

What proportion of mutual funds truly, after accounting for luck, generate positive alpha? Is there a reliable way to find such funds? In the March 2008 version of their paper entitled “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas”, Laurent Barras, Olivier Scaillet and Russ Wermers apply a new technique to measure the role of luck across a large sample of mutual funds. Using monthly returns for 2,076 U.S. actively managed domestic equity mutual funds (1,304 growth, 388 aggressive growth and 384 growth and income) existing for at least 60 months during 1975-2006, they conclude that: Keep Reading

The Wall Street Journal’s SmartMoney Fund Screen

Does the Wall Street Journal’s SmartMoney Fund Screen help its readers beat the market? In the February 2008 version of their paper entitled “Do Mutual Fund Media Recommendations Hold Value? An Empirical Analysis of the Wall Street Journal’s SmartMoney Fund Screen”, George Comer, Norris Larrymore and Javier Rodriguez employ two methods to test the performance of mutual funds listed at the ends of the Wall Street Journal’s SmartMoney Fund Screen columns during the year before and the year after publication. These weekly columns flag top performing mutual funds based on criteria such as fund objective, historical returns and expense ratios. The authors collect and assign the funds in these lists to one of five fund categories: domestic equity, international equity, sector, hybrid (asset allocation and balanced funds) and fixed income. Using daily returns for 399 mutual funds (263 unique) listed during 2005, they conclude that: Keep Reading

A Fresh Hedge Fund Horse Every Couple of Years?

Do hedge funds have a predictable life cycle? If so, can investors exploit it? In his January 2008 draft paper entitled “The Life Cycle of Hedge Funds”, Dieter Kaiser investigates whether excess returns diminish as a hedge fund ages perhaps because: (1) successful hedge funds outgrow their target markets; (2) good returns attract other investment managers who compete for similar inefficiencies; and/or (3) successful hedge funds outgrow their founding entrepreneurial spirits. Using return data for an initial sample of 1,433 hedge funds over the period January 1996 through May 2006, he finds that: Keep Reading

Reliable Outperformance Among Bond Fund Managers?

Does past performance predict future results for bond funds? In their April 2007 paper entitled “‘Hot Hands’ in Bond Funds”, Joop Huij and Jeroen Derwall measure persistence in the relative performance of bond mutual funds. Using return data for 3,549 bond funds spanning 1990-2003, they find that: Keep Reading

Do Hedge Fund Investors Chase or Successfully Time Returns?

Are presumably sophisticated (or at least wealthy) hedge fund investors on the whole past return chasers or future return finders? In their November 2007 paper entitled “Aggregate Hedge Fund Flows and Asset Returns”, Ashley Wang and Lu Zheng answer these questions in aggregate by analyzing the overall flow of money into and out of hedge funds. They also examine separately flow patterns for ten hedge fund categories: convertible arbitrage, dedicated short bias, emerging markets, equity market neutral, event driven, fixed income arbitrage, global macro, long/short equity, managed futures and multi strategies. Using quarterly hedge fund flow and return data across the ten fund categories from first quarter 1994 to first quarter 2007, they find that: Keep Reading

Do Hedge Funds Play the “Famous” Anomalies?

Do hedge funds systematically exploit the major stock return anomalies? Or, do they earn their keep (if they do) via more arcane strategies? In their January 2008 paper entitled “Do Hedge Funds Arbitrage Market Anomalies?”, Dan Lawson and David Peterson apply a seven-factor model (market, size, value, momentum, earnings momentum, equity financing and asset growth) to investigate whether hedge funds successfully exploit market anomalies. They also examine whether hedge funds generate abnormal returns separately from these “famous” factors. Using detailed data on 1,460 individual hedge funds involving 21 types of strategies and stock return anomaly data for the period 1990-2005, they find that: Keep Reading

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