Mutual/Hedge Funds

Has dramatic growth and proliferation of hedge funds used up all the alpha, or do opportunities for excess returns still abound? In their October 2006 paper entitled “Net Inflows and Time-Varying Alphas: The Case of Hedge Funds”, Andrea Beltratti and Claudio Morana investigate whether dramatic asset growth has eroded the performance of hedge fund managers. Their analysis encompasses the following categories of hedge funds: convertible arbitrage (CA – 8%), dedicated short bias (DSB – 1%), emerging markets (EM – 4%), equity market neutral (EMN – 7%), event driven (ED – 17%), fixed income arbitrage (FIA – 7%), global macro (GM – 11%), long/short equity (LSE – 32%), managed futures (MF – 5%). The percentages indicate the share of total hedge fund assets by category as of December 2005. Using quarterly fund net returns and asset flows and appropriate return benchmarks for each fund category over the period 1994-2005, they conclude that: Keep Reading

Do mutual fund investors move their money into and out of the stock market at the right times, or the wrong times? In their August 2006 paper entitled “Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability”, Geoffrey Friesen and Travis Sapp examine the flows of funds to/from individual mutual funds to measure the timing ability of fund investors. They define a “performance gap” between the time-weighted (buy-and-hold) return and the dollar-weighted (actual investor average) return as the measure of investor timing ability. Using monthly data for 7,125 mutual funds over the period 1991-2004, they find that: Keep Reading

Do mutual funds that implement the tenets of behavioral finance, in defiance of the Efficient Market Hypothesis, outperform? Can they find and exploit systematic behavioral mispricings? In their August 2006 paper entitled “Behavioral Finance: Are the Disciples Profiting from the Doctrine?”, Colby Wright, Prithviraj Banerjee and Vaneesha Boney assess whether expert investors have validated the principles of behavioral finance by examining the aggregate performance of a group of mutual funds that practice them. Using equal-weighted data for 16 mutual funds most visibly associated with behavioral finance (see table below), they find that: Keep Reading

Do equity hedge fund managers achieve positive alpha by timing the market or by picking (for or against) the right stocks? In their July 2006 paper entitled “How Hedge Funds Beat the Market”, Craig French and Damian Ko investigate the degrees to which these two potential sources of excess returns contribute to market outperformance by hedge fund managers. Using monthly returns for a sample of 157 long-short equity hedge funds reporting over the entire period 1996-2005, they conclude that: Keep Reading

Do hedge funds eliminate, or even reverse, seasonal effects in the returns of the stock market? In his September 2006 paper entitled “Seasonality in Hedge Fund Strategies”, Yan Olszewski investigates general seasonal effects for various hedge fund strategies. Using monthly excess return data during 1990-2005 for 30 of the 37 equally-weighted Hedge Fund Research strategy indexes encompassing over 1600 funds, he finds that: Keep Reading

Is it possible to replicate the returns of hedge funds by decomposing these returns into contributions from easily tradable risk factors? In the August 2006 draft of their paper entitled “Can Hedge-Fund Returns Be Replicated?: The Linear Case”, Jasmina Hasanhodzic and Andrew Lo investigate simple models of the performance of 11 types of hedge funds based on six risk factors (related to stocks, bonds, currencies, commodities, credit, and volatility). They then use the results for the five factors that are easily tradable to create hedge fund “clones” (synthetic hedge funds) from exchange-traded assets and derivatives in two ways: (1) applying data from the full sample period (with the associated look-ahead bias); and, (2) applying data from a rolling historical 24-month period. Using data for the period February 1986 through September 2005 on 1,610 hedge funds still active (“live”) at the end of the period, they find that: Keep Reading

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

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

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

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