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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.

Better to Have a Fund Manager with an Ownership Stake?

As of 2005, the Securities and Exchange Commission requires most mutual funds “to disclose…each portfolio manager’s ownership of securities in the fund” using dollar ranges. Should investors favor funds in which the fund managers hold direct stakes? In other words, do funds with management ownership outperform? In their August 2006 paper entitled “Portfolio Manager Ownership and Fund Performance”, Ajay Khorana, Henri Servaes and Lei Wedge exploit the new data to test the relationship between fund manager ownership and fund performance. Using monthly return data for a sample of 1,406 mutual funds having ownership data available as of the end of December 2004, they find that: Keep Reading

Mutual Fund Advertising: Does Harrison Ford Offer a Better Return?

Do the billions of dollars of annual mutual fund advertising work to attract investors? If so, are the appeals rational or emotional? Does the advertising connect investors with the right funds? In his July 2006 paper entitled “Advertising and Portfolio Choice”, Henrik Cronqvist examines how mutual fund industry advertising affects investor choices and returns. Focusing on the effects of 50,000 multimedia advertisements by 454 funds on 4.4 million workers during the year 2000 launch of a new pension system in Sweden, he finds that: Keep Reading

A Warm Embrace or Cold Shoulder for Hot Hands?

Do sophisticated (wealthy) investors chase hedge fund returns? If so, should they? In their March 2006 paper entitled “Do Sophisticated Investors Believe in the Law of Small Numbers?”, Guillermo Baquero and Marno Verbeek investigate whether sophisticated hedge fund investors exhibit “hot hands” bias by overreacting to small samples of fund performance. They hypothesize that investors who believe that hedge fund performance is predominantly skill (luck) are prone to overestimate the likelihood of performance persistence (mean reversion) in small samples, leading to an overly trend-following (contrarian) investing style. Using quarterly performance and funds flow data for 752 hedge funds between 1994 and 2000, they conclude that: Keep Reading

Another Test of Hedge Fund Returns

Do most hedge funds outperform broad market indexes? Do some types of hedge funds do better than others? In their May 2006 paper entitled “The Performance of Hedge Fund Strategies and the Asymmetry of Return Distributions”, Bill Ding and Hany Shawky examine returns for hedge funds in general. They also use four alternative models to investigate the performance distributions of several categories of equity hedge funds, comparing results with broad stock market indexes. Using monthly returns over the period 1990 (466 funds with $16 billion in assets) to 2003 (2,225 funds with $328 billion in assets), they find that: Keep Reading

Indicators of Persistent Fund Manager Outperformance

What makes some mutual fund managers better than others? A series of three recent papers triangulate on the answer to that question by investigating the importance of public and private information to fund managers. Using data for 1,700 equity mutual funds over the period 1993-2002, “Fund Manager Use of Public Information: New Evidence on Managerial Skills” by Marcin Kacperczyk and Amit Seru examines the responses of mutual fund managers to news (changes in public information). Using data for over 2,500 equity mutual funds over the period 1984-2003, “Unobserved Actions of Mutual Funds” by Marcin Kacperczyk, Clemens Sialm and Lu Zheng tests the impacts of unobserved (not immediately or precisely disclosed) mutual fund manager actions on fund returns. Using data for over 2,300 equity mutual funds over the period 1984-2003, “Industry Concentration and Mutual Fund Performance” by Marcin Kacperczyk, Clemens Sialm and Lu Zheng studies the relationship between industry concentration and fund returns. Respectively, these papers conclude that: Keep Reading

Hedge Fund Industry: Declining Performance and Increasing Risk?

Is the hedge fund industry an alpha-generating juggernaut? Does it even really offer a “hedge?” In their March 2006 paper entitled “Hedge Funds: Performance, Risk and Capital Formation”, William Fung, David Hsieh, Narayan Naik and Tarun Ramadorai investigate performance, risk and capital flows within the hedge fund industry over the past ten years. Using a comprehensive dataset of 1,603 Funds-of-Hedge-Funds (FoFs) covering the period 1995-2004, they find that: Keep Reading

The Morningstar Mutual Fund Rating System Works?

Can investors count on the widely cited Morningstar mutual fund rating system as an investment screener? In their recent paper “Morningstar Mutual Fund Ratings Redux”, Matthew Morey and Aron Gottesman investigate the relationship between number of Morningstar stars and future performance of mutual funds since June 30, 2002, when Morningstar overhauled their rating system in terms of granularity, risk measurement and treatment of share classes. Focusing on the three-year performance of domestic equity funds that were rated by Morningstar as of 6/30/02 (1,902 funds) and adjusting for fund loads and survivorship bias, they conclude that: Keep Reading

The Hedge Fund Public Relations Game Plan?

Is this how a savvy hedge fund manager plays the game? First, get cozy with other fund managers, financial market research firms and the financial media. Then “orchestrate” the attention paid to a company in which the manager’s fund has taken a position? Here’s a picture, with some links to relevant allegations and news/commentary… Keep Reading

Just Protecting Their Investing/Trading Reputations?

People worry about their professional reputations. Does this worry on the part of institutional fund managers translate into any systematic investing/trading practices, and thereby create asset mispricings? In the November 2005 update of their paper entitled “Asset Price Dynamics When Traders Care About Reputation”, Amil Dasgupta and Andrea Prat describe a model for incorporating concern about reputation into institutional (mutual) fund manager behavior and compare predictions of that model to results of other research. They conclude that: Keep Reading

Give Me Your Money Because…

Financial services firms must persuade investors to hand over their money. How do they do that? Do these companies rationally present their track records of excess risk-adjusted returns, or do they appeal for funds using less rational messages? In the October 2005 draft of their paper entitled “Persuasion in Finance”, Sendhil Mullainathan and Andrei Shleifer review and interpret trends in financial advertising over the past decade. Their investigative framework assumes that investors shift relative emphasis between two broad investment motivations, growth (getting rich, or greed) and protection (securing the future, or fear), depending on the state of the market. High past returns activate greed, and low past returns activate fear. They use this framework to test the rationality of financial firm advertising. Using 1469 ads from Business Week during January 1994 through December 2003 and 4971 ads from Money during January 1995 through December 2003 aimed at investors, they find that: Keep Reading

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