Hedge Funds: Performance, Risk, and Capital Formation

Fung, William; Hsieh, David A.; Naik, Narayan Y.; Ramadorai, Tarun

doi:10.1111/j.1540-6261.2008.01374.x

Cited by 568 publications

(356 citation statements)

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“…The sample has 2,108 funds and 180 monthly cross-sectional regressions. www.cfapubs.org ©2014 CFA Institute funds outperformed the low-flow (high-outflow) funds by 0.5%-0.9% per month, with the highest outperformance in month t. These differences in alphas are all statistically and economically significant and corroborate the existence of return chasing (see, e.g., Fung, Hsieh, Naik, and Ramadorai 2008). Following the month t flow, the outperformance disappeared very rapidly.…”

Section: Long-term Flow Impactsupporting

confidence: 58%

Flows, Price Pressure, and Hedge Fund Returns

Ahoniemi

Jylhä

2014

Financial Analysts Journal

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O ver the past two decades, hedge funds have experienced large inflows of capital. The academic literature shows that fund flows result in an uninformed demand shift, which may affect asset prices. In this study, we examined the effect that capital flows have on hedge fund returns. Our results are consistent with a mechanism whereby funds respond to flows by scaling their portfolios up or down, rather than diversifying. These trades have a contemporaneous price impact on the funds' underlying assets, leading to an effect on fund-level returns. Reversal of the initial flow-induced price pressure is delayed by the price impact exerted by further performancechasing flows. Our results are similar to those of Lou (2012), who studied mutual fund flows.The existing literature on uninformed demand shocks has mainly focused on studying equity benchmark index redefinitions (Shleifer 1986;Harris and Gurel 1986;Greenwood 2005) and the flow-driven trading of mutual funds in US equities (Coval and Stafford 2007;Chen, Hanson, Hong, and Stein 2008;Frazzini and Lamont 2008;Greenwood and Thesmar 2011;Khan, Kogan, and Serafeim 2012;Lou 2012). In particular, the latter group of studies examined capital flows in and out of mutual funds and investigated the price impacts of the flows on the stocks held by the funds. Compared with these studies, the use of hedge fund data allowed us to examine the flow-related phenomena with a much broader set of underlying assets and investment strategies, including the use of leverage and derivatives. The fact that our results are consistently present across various types of hedge funds shows that flow-induced price pressure is not limited to only equities. 1 Also, hedge funds are able to hold more illiquid portfolios than mutual funds owing to lockup periods. Further, the sequential nature of flows and returns-monthly flows are submitted before the concurrent return is known, which is not the case for mutual fundsallowed us to quantify the contemporaneous effect that flows have on fund-level returns and hedge fund performance attribution.■ Discussion of findings. We arrived at four key findings. First, hedge fund returns exhibit statistically and economically significant flow-induced price pressure: Funds that received high inflows outperformed funds that experienced large outflows during the month of the flows. Second, over the subsequent months, reversal of the initial price impact occurs relatively slowly: On average, full reversal took around 24 months. Third, flowinduced price pressure contributes to the observed persistence in hedge fund returns. Fourth, and maybe most interestingly from a practitioner's point of view, flows have implications for performance attribution: Estimated hedge fund alphas fell by 33% when controlling for flow impacts. These results contribute to the existing literature on flow-induced price pressure as well as to the hedge fund literature. In the next section, we review the related literature and how our results link to and extend this body of research. Literature R...

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Section: Long-term Flow Impactsupporting

confidence: 58%

Flows, Price Pressure, and Hedge Fund Returns

Ahoniemi

Jylhä

2014

Financial Analysts Journal

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“…Following Brown et al (1975), we apply the CUSUM procedure and confirm that the LTCM crisis indeed lead to consistent boundary violations across the two CA portfolios and the three CA indexes. Similar to Fung and Hsieh (2004) and Fung et al (2008), we use the following structural break model to account for the LTCM crisis:…”

Section: The Impact Of Extreme Market Events On Ca Hedge Fundsmentioning

confidence: 99%

Risk and return in convertible arbitrage: Evidence from the convertible bond market

Agarwal

Fung

Loon

et al. 2011

Journal of Empirical Finance

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In this paper, we identify and document the empirical characteristics of the key drivers of convertible arbitrage as a strategy and how they impact the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds ("CBs") while hedging the equity risk alone explains a substantial amount of these funds' return dynamics. In addition, we highlight the importance of non-price variables such as extreme market-wide events and the supply of CBs on performance. Out-ofsample tests provide corroborative evidence on our model's predictions. At a more micro level, larger funds appear to be less dependent on directional exposure to CBs and more active in shorting stocks to hedge their exposure than smaller funds. They are also more vulnerable to supply shocks in the CB market. These findings are consistent with economies of scale that large funds enjoy in accessing the stock loan market. However, the friction involved in adjusting the stock of risk capital managed by a large fund can negatively impact performance when the supply of CBs declines. Taken together, our findings are consistent with convertible arbitrageurs collectively being rewarded for playing an intermediation role of funding CB issuers whilst distributing part of the equity risk of CBs to the equity market.Keywords: Hedge funds, Convertible Bonds, Convertible arbitrage, Supply, Risk Factors JEL classification: G10, G19, G23 1 IntroductionAt the turn of the century, capitalization of the global convertible bond ("CB") market stood at just under $300 billion while the US equity market was more than 50 times higher at over $1.5 trillion. Yet during the difficult market conditions between 2000 and 2002 (with events such as end to the dotcom bubble, September 11, and the accounting scandals at Worldcom and Enron), the new issues in both these markets were of similar orders of magnitude-close to $300 billion. Even during the financial crisis of [2007][2008], firms managed to raise about $118 billion in the US CB market. 1 This underscores the importance of the CB market as a source of capital for corporations during adverse economic conditions. 2To smooth the placement of such a large-scale issuance of CBs, economic agents willing to assume the inventory risk are clearly needed. Coincident to these macro events, the last decade has witnessed a rapid growth of convertible arbitrage ("CA 1 Equity data are from Federal Reserve Bulletin (various issues). We thank Jeff Wurgler for making it available on his website http://pages.stern.nyu.edu/~jwurgler/. CB estimate is from the public and private proceeds of convertible debt from Thomson Reuters Financial's SDC Platinum database, which we also use later on for our out-of-sample analysis. 2 Apart from being a useful source of liquidity to issuers during adverse market conditions, the issuance of CBs depends also on the costs and benefits compared to other forms of securities issuance. Firms selling CBs incur costs inclu...

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“…Fung and Hsieh (2000) argue that the investment returns of FoFs contain fewer measurement biases than those of individual hedge funds (see also Fung et al (2008)). The idea is that the investment experience of disappearing funds will be reflected in the returns of FoFs, which, presumably, are themselves less likely to have stopped reporting to TASS.…”

Section: H Main Results For Funds Of Fundsmentioning

confidence: 99%

Strategic Delays and Clustering in Hedge Fund Reported Returns

Aragon¹,

Nanda²

2017

J. Financ. Quant. Anal.

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We use a novel database to study the timeliness of hedge fund monthly performance disclosures. Managers engage in strategic timing: poor monthly returns are reported with delay, sometimes clustered with stronger subsequent performance, suggestive of "performance smoothing." We posit that propensity to delay could reveal operational risk and/or poor managerial quality. Consistent with this, a portfolio strategy that buys (sells) funds with historically timely (untimely) reporting delivers 3% annual-style-adjusted returns. Investor flows are lower following reporting delays, although there are potential benefits to managers from delaying reporting when performance is sufficiently poor. We conclude that timely disclosure is an important consideration for hedge fund managers and investors.

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Hedge Funds: Performance, Risk, and Capital Formation

Cited by 568 publications

References 33 publications

Flows, Price Pressure, and Hedge Fund Returns

Flows, Price Pressure, and Hedge Fund Returns

Risk and return in convertible arbitrage: Evidence from the convertible bond market

Strategic Delays and Clustering in Hedge Fund Reported Returns

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